Wayne O’Leary

The Big Gamble

It’s obvious now that President Obama will not, except as a last resort, exercise the “nuclear option” and break up or temporarily nationalize America’s insolvent megabanks. Instead, he and his economic advisors will employ a so-called public-private partnership, using mostly public money, in an attempt to prop up and reenergize the existing financial system.

As I write this, the giant TARP recipient Wells Fargo & Co. has just announced a record $3 billion profit for the first quarter of 2009, stimulating momentary euphoria on Wall Street and pushing the Dow a couple of hundred points higher. Other banks did less well, but better than expected. So, this may be the light at the end of the tunnel, and the Obama-Geithner financial-rescue plan may actually be working after all.

Or maybe not. Wells Fargo could be the exception that proves the rule—one of the few bright spots in a continuing downward spiral. New York University’s prescient economist Nouriel Roubini estimates US banks will still lose $1.8 trillion (13% of GDP) on their securities and loans over the next three years, perhaps as much as $700 billion in excess of earnings. Either way, hit or miss, the financial plan is one of the few black marks against a president who, so far, has done most things right. If his subsidy scheme to save the banks works, some of the same people culpable in the crisis stand to become the prime beneficiaries; should it fail, we as a country will be paying the price for years to come.

Success will mean that crime, in its broadest sense, pays and that greed, in the words of Gordon Gekko, is good. The president acknowledges this; he says he’s as outraged as the rest of us. But is he, really? Barack Obama is not the sort to get truly worked up emotionally; he’s far too laid back for that. He approaches issues coolly and cerebrally, and his objective from the start has been two-fold: 1) to save the economy, and 2) to preserve the financial structure his advisors tell him is the source of all wealth.

Treasury Secretary Geithner has devised a truly diabolical recovery plan and persuaded the president to sign off on it. Troubled bank assets (collateralized debt obligations, credit-default swaps, and similar securities derivatives) will be purchased, then resold, with the Treasury (that’s us) and private investors (hedge- and private-equity funds) putting up the equivalent of one dollar each and the Federal Reserve and FDIC throwing in an additional $12 in the form of insurance guarantees and other financing. If the toxic assets can be disposed of at a profit, the private investors and the Government share equally; if they can’t, the Government assumes the losses.

In theory, once the bad paper is off the banks’ books, they will resume lending, and the economy will thrive happily ever after. The investors, meanwhile, will cash in big-time (50% of the profit on a 7% investment, most of it borrowed from the Government). Of course, the taxpayers could be out $1 trillion or so, if things break badly, while the investors walk away free and clear.

Economist Robert J. Samuelson justifiably calls this “Geithner’s hedge fund.” There must be a better way. Not to belabor the point, but nationalization and recapitalization of restructured (i.e. smaller, more narrowly focused) banks is still the superior alternative. It would ideally be carried out in conjunction with a new, updated Glass-Steagall Act that would segregate financial services once more and see to it that commercial banks concentrate on what they do best, actual banking (taking deposits and making loans), and stay out of the insurance and investment businesses, the disastrous detours leading to their present zombie status.

The worst aspect of the current financial crisis is that megabanks used the 1999 repeal of Glass-Steagall not just to expand into areas beyond their expertise, but to deliberately become “too-big-to-fail” in order to acquire unofficial federal bankruptcy insurance—becoming so large and economically pervasive that the Government would have to bail them out to avoid potentially disruptive dislocations in the economy. This is partly what’s behind the relentless bank mergers of recent months, which continued even under the TARP. According to BCA Research, the swollen financial-services industry—that is, the multi-dimensional “banks”—accounted, at its peak in 2007, for two-fifths of total US corporate profits and one-fifth of total stock-market value, while producing barely 5% of all private-sector jobs.

Such minimal impact on employment suggests it wouldn’t hurt the economy all that much if some of the zombie megabanks went under or shrank in size, so long as loan money remained available. It further raises the suspicion that what’s really at stake here is the stock market and the welfare of the investor class—Wall Street rather than Main Street. Other countries have done quite well, thank you, without private megabanks dominating their economies. In fact, those nations handling the worldwide downturn with the least financial disruption are those with either a tightly regulated private-sector banking system (Spain, Canada), or those in which small, publicly owned institutions predominate (Germany, India).

Spain, which has ridden out the financial crisis with no bank failures, has a system based on community-run mutual savings banks overlaid by a few large, private national institutions closely supervised by a central bank. The regulator, the Bank of Spain, forced Spanish bankers to set aside sufficient capital to cover loans and investments, and monetarily penalized speculation in derivatives. The result is a healthy system without the leverage problems seen elsewhere.

Germany is an example of a mixed public-private system, whose publicly owned local banks, the so-called sparkassen (a $1 trillion network of over 400 government-run savings and loans), have avoided difficulties, while its large, private investment banks, typified by financial-services entity Deutsche Bank, have been caught in the speculative turmoil. German investors have predictably taken a bath, but Germany’s Everyman, seeking a home or auto loan, or dependent on his savings, has not suffered.

The lesson here should be obvious: Obama’s economic team needs to disenthrall itself from “the market” and drag the banking sector, kicking and screaming, into the 21st century. That means sending Geithner back to the drawing board.

Wayne O’Leary is a writer in Orono, Maine.

From The Progressive Populist, June 1, 2009

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