10/18/2010 10:23 am ET | Updated May 25, 2011

The Coming Battle

The battle immediately in front of us, of course, is this fascinating, unpredictable election season. Everyone in Democratic and progressive politics is doing everything they know how to turn back a Republican tide, and the polling shows some interesting possibilities: it is ugly out there, but still not impossible to imagine Democrats avoiding the worst. Smart folks like Stan Greenberg, Bob Creamer, and Simon Rosenberg see some signs of life out there. I think voters are still trying to decide which party they dislike the most, and these last couple of weeks there will be some last minute trend one way or the other that will make things far worse or quite a bit better than anyone is predicting right now.

But for the purposes of this post, I want to take a moment to look ahead to the next big battle that will face us no matter what happens on election day. Our next big battle is an unavoidable fight about economics that goes to the core of whether the economy will start to improve, and whether the big banks will be in control of our government. It will be at least initially less a legislative fight than a battle over how Obama and his team will respond to the latest huge challenge in front of them, the foreclosure mess. Our economic system has been done far more damage by the last decade of recklessness in the financial industry than most conventional economists and policy makers understand, and the Bernanke/Paulson/Geithner rescue revived but did not restructure the financial industry. The toxic assets on the books of the big banks, which are primarily in the terribly damaged real estate sector, were never resolved, and are still sitting there like a huge millstone hung around the necks of these banks. The only reason the banks looked healthier in the last 18 months is that their lobbyists were able to get the accounting board to change the rules so they could value those real estate assets at whatever imaginary number they needed to in order to get profits and bonuses showing up on their books again.

The banks' strategy for getting this mess cleaned up was to run huge numbers of people through this fraudulent and obscene foreclosure mill process, but the law and community organizations have caught up to them, and the process is bogging down into a slow moving morass that, for the second time in 2 years, is threatening the very existence of these big banks. Herein lies our country's next big political and economic battle. The bankers who got themselves and all the rest of us into this mess will once again argue that they are too big to fail, that the health of our entire economy depends on their ability to cut legal corners with homeowners' legal rights, and that they might even need other kinds of bailouts from the government to survive. The argument will be that if we don't push all these foreclosures through ASAP, the entire housing market will sink even lower into the pit it is already in, and the economy will go from weak to terrible. And if these banks themselves fail, we will be told, we will see another great depression set in.

There are other policies that could be pursued, though. Thoughtful economists have been putting out a mix of proposals that could be successful in keeping more people in their homes, stabilizing home prices, and other measures that would help rebuild the middle class that has been so harmed by the last decade's economic trends. These policies include a large scale principal reduction program for distressed homeowners, creating a right to rent for homeowners whose home prices have fallen so much their mortgages are under water. Such policies would create big losses for the banks, but given all their profits and bonuses over the last decade, I'm certain the Wall Street tycoons and government regulators could figure out a way to keep these banks going. The cowboy traders for these companies probably wouldn't be getting any bonuses for a while, and that would cause some howling, but I think our system would survive their having to cut back purchases of $6,000 bottles of wine for a while. It might even force these banks to restructure themselves, perhaps even breaking themselves apart (there would be nothing more healthy for our economy than that event). So the bank lobby and their sycophants in the media will be in high gear, trying to make sure nothing happens that would scale back their power and profits, threatening us with the end of the world, but we need to push back hard against them.

This debate is different from the one we went through a couple of years ago, the main reason being what we went through over the last couple of years. There is no political will in either party, no matter how much many politicians and policy makers want to help their banking industry friends, for another big bailout of Wall Street. If the bank lobby could sneak something through without anyone noticing, as they came very close to with this mortgage modification bill Obama vetoed, that could work, but having failed at their first attempt and the foreclosure fraud crisis now being in the center of the public eye, that will be tougher to do now. With tea party populists and progressives united in not wanting to bail out the banks again, and with the immense unpopularity of TARP, straightforward bail out bills will be very tough to pass. Bernanke will use all his tools to help grease the wheels for the industry, but he doesn't have as many tools in the toolbox as he used to, and if the actual law on these foreclosure proceedings is not changed, Bernanke may not have the ability to help as much as he would like. The biggest question at this point is the Obama administration, and they are genuinely divided on how to move forward. There are still those in powerful positions inside the administration who believe that the fate of the economy is inextricably tied to the financial well being of the Wall St financial sector. There are others inside, especially Elizabeth Warren but also influential people like Volcker and Goolsbee, who are more skeptical about the big banks being the end-all and be-all of the country's economic health.

How all this plays out will be the central, fundamental issue by far in how the next two years of this administration turns out. The economy is too damaged to get healthy without a restructuring of the housing sector in a way that actually benefits the middle class. If the banks win this battle, I fear we are stuck with deflation, high unemployment, and low housing prices stretching several years out, and in that circumstance, the President's future political prospects look pretty bleak. However, if the President sides with homeowners on these issues, and creates a path out of this mess that actually helps strengthen the middle class, he will have new momentum going forward. Whatever Congress is elected a couple of weeks from now, this issue will be mostly resolved within the administration, and if Obama proves himself a champion of the middle class in opposition to the bank lobby, he will be well-positioned for future fights no matter how the 2010 elections turn out.

Cross-posted on, where you can read all of my analysis of elections and governance.

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