Obama must do more

As the US senate debates US president Barack Obama's stimulus plan, there is growing concern about what he will do to rescue the financial system. Pay caps on Wall Street executives are not enough – Obama may need to buy back some banks.

"For better or worse, Obama's 'honeymoon' period is now over," declared economist Tyler Cowen this week. Cowen based his pronouncement on the news that Senate Democrats are acknowledging that they don't have the votes to ram through their version of the stimulus plan.

It may be hasty to dance on the stimulus plan's grave just yet. There was always going to be haggling in the Senate over the precise make-up of the bill. The fact that a couple of days ago the price tag for the bill was rising, and now there are reports that it may be slashed, doesn't tell us a whole lot about what will happen next week, or whenever the Senate finally votes on a proposal. (And there had better be a vote – if Democrats don't force a real filibuster on a bill to restart the economy, one does despair that they will ever show any backbone on any issue.)

But if you really want to hear the sound of Obama's "honeymoon" shattering against a brick wall, head to Naked Capitalism, where Yves Smith is apoplectic over the latest details on how the Obama administration plans to deal with the financial crisis on Wall Street.

The Obama Administration is as obviously and fully hostage to the interests of the financial services industry as the Bush crowd was. We have no new thinking, no willingness to take measures that are completely defensible (in fact not doing them takes some creative positioning) like wiping out shareholders at obviously dud banks (Citi is top of the list), forcing bondholder haircuts and/or equity swaps, replacing management, writing off and/or restructuring bad loans, and deciding whether and how to reorganize and restructure the company.

Smith's ire was provoked by a Washington Post story that outlined a three-pronged approach to the financial bailout, the details of which are supposed to be announced by Treasury Secretary Geithner next week. According to Binyamin Appelbaum and David Cho, the Obama administration plans to set up a "bad bank," which will take some of the worst performing "toxic assets" off the balance sheets of banks, will continue to expand a loan guarantee program that backstops banks against further losses, and finally, will inject additional capital into troubled institutions.

Given the current popularity of Wall Street with the rest of America, the plan as described is certain to inflame sentiments. Thus the move by the Obama team to enforce pay caps on executives at banks that get large dollops of government aid. A more obvious attempt to provide political cover for the trillions of additional taxpayer dollars to be funnelled to the malefactors that drove the US economy off the cliff could hardly be imagined.

(Perhaps worth noting: A Bloomberg News report on the emerging plan differs somewhat from the Post's take, describing Geithner and Obama economic advisor Lawrence Summers as eager to minimize the bad bank strategy, on concerns that is too expensive and too difficult to implement, in favour of a more robust debt guarantee plan, which would presumably be implemented in return for lending commitments from the banks.)

So what should be done instead? There's hardly any unanimity among the critics of the current approach. Some advocate full nationalisation of the banking sector, while others are already decrying Timothy Geithner as a heavy-handed "statist." Some Republicans appear to be inching toward letting the market solve the problems of how to value the "toxic assets" currently sabotaging the bottom lines of ailing banks -- a strategy that would undoubtedly mean the bankruptcy of some of the biggest financial institutions in the world amid gigantic financial losses.

There are no easy, cheap or obvious solutions. But it might be instructive, at this point, to review Sweden's experience with bank nationalization in the early 1990s. As described last week in the Economist, Sweden's approach included three steps. 1) Sweden instituted a "blanket guarantee of all bank liabilities." 2) After passing a law allowing the government to nationalize failing banks, regulators followed through in two cases. 3) Sweden also set up its own "bad bank" to "dispose of bad loans" at the two nationalized banks. (Sweden was also prepared to help recapitalize the rest of the banks but eventually found that step unnecessary after the success of the first three.)

Bad banks and loan guarantees – not so different from what little we know of what Geithner is cooking up, is it? Except there's one element missing – direct action that proves the government has teeth. A line needs to be drawn. Sweden may only have nationalised two banks, but that may have been enough to signal its determination to deal with the crisis.

One can only wonder what would happen if the Obama administration decided to make an example of one of the worst offenders on Wall Street, by biting the bullet and nationalizing one of the big boys.

The candidates are obvious: Citigroup or Bank of America. Both banks have proven that their strategy of swallowing up everything in sight is a liability to the economic health of the United States – and the world. Both deserve to be broken up into smaller pieces, their management is begging to be given walking papers, and their profitable units should be sold off at the first opportunity to the highest bidder on the market. The millions of mortgages sliced up into various toxic assets held by those banks could then be modified directly by the government that would now own them, relieving pressure on millions of underwater homeowners.

We don't need to nationalise the entire banking sector. But we probably do, like Sweden, need to guarantee the health of the entire financial system, and find some way to ease "toxic assets" off of balance sheets, along with targeted, strategic nationalization. Both during his confirmation hearing, and in conversations thereafter, Timothy Geithner said that government policy needed to be direct, forceful and swift. Nothing would be more direct than marching into the offices of Citigroup, telling CEO Vikram Pandit to pack his bags, and restructuring the bank from top to bottom.

Again, it won't be easy, and it still will be hugely expensive for taxpayers. Shareholders and bondholders will scream bloody murder, and lobbyists will descend on Washington to call in their chips. But the Obama administration needs to signal that it means business, if it is to accomplish any of the items on its ambitious agenda. Pay caps for executives may be popular, but they won't solve anything. We need more.

{{content.question}}

Mastercard

{{ twilioFailed ? 'SMS Code Failed to Send…' : 'An SMS verification code has been sent ...' }}

Hi {{ user.FirstName }}

Looks like you have already taken a free trial

Please enter your payment details

We have sent you a code via SMS to {{user.DayPhone}}

please enter this code below to complete your SMS verification

We cannot send you a code via SMS to {{user.DayPhone}}

If you didn't receive SMS code please

SMS code cannot be sent due to: {{ twilioStatus }}

Please select one of the options below:

Looks you are already a member. Please enter your password to proceed

Please untick this box when using a public or shared device


Verify your mobile number to proceed…

Please check your mobile number below and press the Send Verification Code button. This will be used to complete your verification in the next step.

Please sign up for full access

Mastercard

Updating information

Please wait ...

Trial

Mastercard
{{ productPrice }} / day
( GST included )
Price $0
GST $0
Discount -{{productDiscount}}
TOTAL {{productPrice}}
  • Mastercard
  • Visa

Please click on the ACTIVATE button to finalise your membership

Mastercard

The email address you entered is registered with InvestSMART.

Please login or select "Don't know password"

Please untick this box when using a public or shared device


Register as a new member

(using a different email)

Related Articles