The time for good options to deal with the banks was in, oh, 1999. That was when the Gramm-Leach-Bliley Act passed, repealing the last of the Depression-era regulations that had kept the American banking system sound for more than six decades. (Yes, the same Gramm who got rich once he left the Senate and joined a big bank, and called us a "nation of whiners.") Now some of our largest financial institutions are Zombie Banks — but we have no Mila Jovovich armed with miniskirt and full arsenal to take them down. They are left with only the most primal instinct: To feed on the Treasury. Resident Evil, indeed.
Paul Krugman makes the case for nationalization today. Socialists Lindsey Graham and Alan Greenspan have also signed on. Economist Nouriel Roubini, who called the crash, says a takeover would avoid throwing good money after bad. Indeed, some of this is not too complicated: Think back to the wreck of the Penn Central railroad, when the government stepped in and created Conrail. Later it was relaunched as a successful public company. Receivership is a better way to think of this than the charged word "nationalize."
Who loses? The shareholders. And as much as one might get a populist shiver up the leg from the idea of some big hedge funds getting sucker punched, remember that average Americans were lured into the market, too. They've lost about half their nest eggs already. Those in bank stocks — and Bank of America and Citi are widely held — will lose more. But, as Jovovich's Alice teaches us, you can't mow down a bunch of zombies without collateral damage.
The Dow continues to fall, and one wonders if the best-and-brightest in the Geithner-Summers-Rubin camp get it. The answer is not to give the zombies more dollars to eat (but we know Rubin has already be bitten and soon will turn). We need a clear and transparent receivership. Markets hate uncertainty. Sure, the players on Wall Street want a pony. But they'd settle for getting the bad news straight up. The old bubble economy is dead. We have to move on.
Obama faces a much more complicated task than Franklin Roosevelt in 1933. Now the banks are too big and too complicated. For example, many of their "assets" have no value — they are the same thing sold over and over as derivatives. Many assets have been securitized and long since pushed out the bank's doors into the market. That's why receivership should be coupled with reform. Here's a start:
1. The existing top executives are gone, with all compensation packages voided. If companies can enter bankruptcy court with the explicit intention of voiding their workers' pensions, why should we support these toffs? And don't talk to me about a "brain drain." The guys in the BofA mail room could have done a better job than Ken Lewis in running the bank. As I have written before, bring the old-school bankers out of retirement and seek out the middle-managers who were forced out for questioning the bosses' rush to disaster.
2. Oversee an audit of what's real and what's not. Unleash the lawyers to go after the swindlers — including former and current CEOs. Then, in an orderly and transparent fashion, return the banks to being banks. E.g., no securitization of loans. No investment banking.
3. Break them up into smaller institutions, and scatter the headquarters. This will make it easier for them to fail in the future, be taken over as the FDIC does every Friday with a few small banks, and it will ensure the top executives know there will be no Uncle Sucker to prop up their frauds and swindles. So they will be less inclined to make them.
4. Bring back smart regulation, a Glass-Steagall Act for the 21st century. Banks are not the place for financial plays.
Oh, oh, we will be told. This can't be done. Banking is too, er, too! We need derivatives to survive! We need investment banking fee income from driving mergers that destroy the jobs of average people! We need double-digit profit growth every quarter!!! The reality is that the nation needs a sound banking system. The Gramm Economy is dead. Zombies are clever and they never go down easy.
Lock and load.
The problems of the banking sector stem from two factors: (1) locked credit markets resulting from decreased consumer demand and from the expectation that this decrease will linger or worsen for at least the next two years; (2) inadequate capitalization due to non-performing assets in weak or collapsed markets, whose conditions are also expected to deteriorate.
There are 110 million U.S. households. If, instead of the current stimulus package, the government mailed a check to the bottom third of households (by income) — say, 35 million households — then for the same cost as the $800 billion existing stimulus, each would receive approximately $23,000.
Even after paying off their debts and bills, the typical household would have a sizeable sum left over for consumption; and the bottom third of the population are more likely than any other group to spend this money on consumption — thereby increasing demand — rather than putting it aside as savings, since they have many unmet needs and wants.
Just imagine the effect this would have on the economy as, in effect, the working class would be (temporarily) transformed into a consumer middle class. Businesses would sell far more goods and services, hiring workers to handle this (instead of laying them off), and expanding operations (rather than closing them down or cutting back on them).
Lenders, in turn, would see a large increase in performing assets on their books, as new business loans generated interest payments from businesses servicing the loans.
The effect would also support the wholesale sector as increased consumer demand required increased business inputs.
The checks could be phased in over two years or even divided into monthly or quarterly payments in order to avoid inflationary effects, and to provide a steady stream of increased demand rather than a spike which bursts and quickly fades.
Businesses would also be able to point to a steady and dependable stream of increased revenues in applying to lenders for loans to support business operations and expansions, thereby making such loans more attractive as investments to lenders, thereby unlocking the credit markets.
Of course, some of these households consist of a single individual, while others have several children, but adjustments in check sizes could be made on this basis. To identify such households, the Treasury Department could program I.R.S. databases to spit out a list sorted by payroll tax withholdings, without much trouble.
This version of a stimulus package could be implemented quickly, and its effects would begin immediately.
It would furthermore maintain economic links between consumer spending, on the one hand, and business performance, including the desirability of products and services as judged by consumers, thereby disarming conservative criticisms of bureaucratic interference and ineptitude, not to mention “pork”, since the government would be limited to a strictly intermediary role.
This would still leave “toxic” assets on the banks’ books, in the form of bad housing loans; but the problem of continued foreclosures which threatens to further depress housing values (and thus the value of the banks’ housing loan assets) would be stemmed, as would difficulties with commercial real estate loans, which face similar problems as businesses fail in a deep recession.
As the real estate markets take a deep breath of relief, we would also likely see a gradual but steady increase in property values, and this in turn would “detoxify” many of the problem bank assets by bringing market values more into line with their book values.
Remember, the bottom third of households are also the most at risk of default and foreclosure, so this kind of stimulus package would get the most “bang for the buck” in this area as well, since part of their spending would underwrite the housing market.
Additional measures needed to deal with this problem, such as legislation forcing lenders to adjust mortgage terms, to permit loans to be repaid over a longer period at reduced monthly costs to homeowners, could easily be implemented. Note that this would not reduce total loan payments, nor would it encourage “moral hazard” since in order to qualify, homeowners would need to demonstrate a history of good faith payment attempts in court before a judge, supported by income and expense records. Alternatively, such renegotiations could actually increase the total loan amount to be repaid, by extending the loan period (i.e., more payments at lower monthly cost to the householders, but a larger total amount to be repaid than was originally the case). This also would eliminate the problem of “moral hazard” by making mortgage renegotiation less desirable than continuing payments under current terms, though care would need to be taken to legislatively ensure that these increases were kept relatively modest.
A stimulus package of this kind would also result in vast cost-savings to the federal government (and to state and local governments) since the need for unemployment insurance outlays, health insurance bridge outlays (e.g., COBRA supplements), food stamp outlays, and other recession related expenditures, would be greatly curtailed by a recovering economy, at the same time that tax revenues increased for the same reason.
Furthermore, cash outlays to banks would be dramatically curtailed, since the resulting structural improvements to the economy would not only restore confidence within the banking industry and elsewhere in the financial markets, but would also eliminate the need (real or perceived) for banks to come begging for tens or hundreds of billions of dollars every few months.
The results, in fact, would be so fruitful that an increase in the size of the stimulus, or an extention of it, would be justified if deemed necessary or prudent, and would practically pay for itself in terms of increased tax revenues and decreased government expenditures over a period of several years.
It would also be a good idea to gradually ramp down the size of stimulus checks as the upper end of the income range of recipients is approached, so that economically similar households do not experience arbitrary differences in treatment, with some just below the cut-off point receiving huge checks while those just above receive nothing.
The current stimulus plan, though likely to have positive effects, is inadequate in certain respects and weak in others. A package which merely prevents things from getting worse than they otherwise would have, and does so ambiguously and in a manner difficult to prove and subject to debate, is unlikely either to silence Republican critics or enrapture the public.
Furthermore, a plan which fails is likely to set the Democrats back for many, many years by giving Republicans (who voted as a bloc against it) an enduring “I told you so”.
True, it seems rather late in the game for major changes, but the existing plan has yet to be implemented, and the government has already vacillated so much in similar endeavors (e.g., TARP and the details of the financial bailout) that more fundamental revision, for a good cause, ought to be possible.
The Republicans would likely oppose the new plan because tax cuts for corporations and the well to do service their core constituencies, whereas redistribution of income to the bottom third of the population does not. (Of course, tax cuts for businesses do not in themselves stimulate DEMAND or address the other problems, and tax cuts for the wealthy would more likely (and in greater proportion) fuel speculative investments or else saving, rather than the kind of increase in general consumption which circumstances require.
Democrats, some of whom are as far from populists as Republicans, would also likely resist, but for somewhat different reasons overall, and less strenuously. Such a stimulus plan would not fund their pet projects (admirable as some of these are), and would remove government from the decision making loop, relegating it instead to the position of a mere broker.
My advice to the Democrats would be, attend to first things first. If the Republicans, as the minority party, with no partisan interest in seeing the Democratic majority succeed, continue to resist, pass the measure over the heads, because nothing would strengthen the Dems’ position better than an effective plan which decisively and clearly restores the economy to health.
Once the public sees that “big government” can successfully pull the country out of a crisis, they will, a few years down the road, be all the more inclined to support the kinds of initiatives beloved by Democrats (some of which can even be supported by good arguments).
Meanwhile, the bottom third of the population, having had a taste of the good life, will finally come to understand the practical importance of politics in their lives, and would support measures to continue redistributive policies via progressive taxation of the wealthy. Much of the rest of the population, seeing the broad economic benefits of redistributive policies, would also be receptive.