In most areas of public policy the Obama administration has given the country a sharp and welcome break from the policies of the prior administration. Unfortunately, this is not the case with his financial policy. To a large extent Treasury Secretary Timothy Geithner has continued the Bush-Paulson "save the banks" first approach.
Geithner has continued policies initiated in the Bush administration whereby the banks received vast amounts of money from the public trough while offering relatively little in return. Most of the executives at these banks continue to earn multi-million dollar compensation packages and the shareholders and bondholders have been enriched at the taxpayers' expense.
It is undoubtedly painful for the public to see their tax dollars going to reward the people who are most directly responsible for the economic crisis. The Wall Street banks played a game of high-stakes poker over most of the last quarter century. In the process, the major actors got incredibly wealthy at the expense of ordinary working people.
Now this game has blown up in their face, effectively bankrupting most of the big players, and bringing the economy down in the process. But rather than leave the bankers to suffer the consequences of their own actions, Geithner and Co. are rushing to the rescue with gigantic buckets of taxpayer dollars.
The rationale for this policy is not clear. We have been warned about an implosion even worse than that created by the Lehman bankruptcy if the government follows normal procedure and puts bankrupt giants like Citibank into an FDIC receivership, as is done all the time with smaller banks.
While Secretary Geithner believed that the system could absorb an uncontrolled Lehman bankruptcy last fall, he is now effectively telling the country that even the controlled failure of a major bank would lead to catastrophe, and that taxpayers should be prepared to spend hundreds of billions and possibly trillions of dollars to keep the zombie banks afloat.
It is hard to understand this logic. First, Geithner, along with Federal Reserve Chairman Ben Bernanke and then Treasury Secretary Henry Paulson, were not crazy to believe that the system could withstand an uncontrolled Lehman bankruptcy, even if was in fact a mistake to let Lehman go under. More importantly, we have a number of safeguards now in place to protect against the sort of panic that followed the collapse of Lehman. There seems little justification for continuing to spread the wealth around to those at the very top of the income ladder.
To justify the upward redistribution implicit in the Geithner policy there have also been serious misrepresentations of the state of the financial system. While the banks certainly are not functioning normally, their condition is not the major obstacle to recovery.
Households with good credit have no difficulty whatsoever getting mortgages as a result of the policies of the Fed and Fannie Mae and Freddie Mac. Mortgages are readily available at near record low interest rates. Those with poorer credit histories do have trouble, but this would almost certainly be the case even if the banks were fully solvent.
Large businesses with investment grade credit can readily issue commercial paper through the Fed to deal with their short-term credit needs. In recent weeks, several major firms have also issued bonds at relatively low interest rates, indicating that long-term credit channels are returning to normal for these firms as well.
While smaller and less creditworthy businesses are undoubtedly having more difficulty than usual obtaining credit, this is not the main factor depressing the economy. The basic story is that households are in the process of losing $8 trillion in housing bubble wealth. This has both collapsed housing construction and forced consumers to cut back spending.
The fall in consumer spending is not due to lack of credit or insufficient confidence, it is due to the fact that the average homeowner is losing more than $100k in equity and is now trying to save to make up this lost wealth. There was also a bubble in non-residential real estate, which is now collapsing, further depressing the economy.
In the short-term the only way to make up for the shortfall in demand is with government spending. We will need far more stimulus to make up a gap in spending that is in the neighborhood of $2.5 trillion over a two-year period.
In the longer term we will have to get the trade deficit down to a sustainable level. Moving to more balanced trade will require a large fall in the value of the dollar, which is the key step in correcting our large trade imbalance.
The Obama administration has yet to get serious about setting the long-term economy on a sound footing by bringing the value of the dollar down to a competitive level. Instead it has focused on rescuing the banks with taxpayer dollars. Throwing money at the banks will make the bankers happy - rescuing them from their own incompetence - but it will not set the economy right.
In the area of financial policy the Obama administration gets poor marks for its first 100 days. Instead of a letter grade, we'll just say: "needs improvement."
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