I recently spoke at a Federal Reserve conference in Chicago, on financial regulation. The keynote speaker was Ben Bernanke. Chairman Bernanke was unable to leave Washington, so he spoke live, via a giant TV screen, giving his speech a fittingly Orwellian cast.
This was the day that the results of the so called stress tests were released. Not surprisingly, Bernanke was upbeat, since restoring confidence was the whole political point of the stress-test exercise. No major bank was insolvent, and the 19 largest banks collectively needed to raise only about $75 billion in additional capital, although their losses might total as much as $599 billion. Citigroup, queen of the Zombie Banks, remarkably enough, was said to need only $5.5 billion in additional private capital. You could almost make up that paltry sum with executive bonuses.
At one point in his remarks, Bernanke, recounting just how rigorous the stress tests were, explained that "More than 150 examiners, supervisors, and economists" had conducted several weeks of examinations of the banks. That kind of let the cat out of the bag. If you do the arithmetic, that is about seven supervisors per bank, and all of the stress-tested 19 banks were hundred-billion and up outfits. When an ordinary commercial bank, say a $10 billion outfit, undergoes a far less complex routine examination of its commercial loan portfolio, it involves dozens of examiners.
So the stress test was not a set of rigorous examinations at all, but a modeling exercise using the banks' own valuations of their assets. The most serious outside observers think the hole in the banks' balance sheets is much larger than $75 billion or even the Fed's worst-case estimate of $599 billion in losses. The International Monetary Fund estimates the hole as more like 2.7 trillion dollars, and informed economists like Nouriel Roubini put the number at as much as 3.6 trillion.
Why is the Fed low-balling the problem? The hope is that by keeping the banks afloat for a few more months, and trying to entice private capital back to the table, the recovery in other parts of the economy will spill over onto the banks. But the greater likelihood is that weakened banks will continue dragging down the rest of the economy.
Despite talk of "green shoots," - economic indicators not being quite as bad as expected, and the stock market up - most of the news is still pretty grim. Unemployment was up in April by "only" 539,000 jobs. Home foreclosures keep rising, with a total of eight million projected this year. Manufacturing is dead in the water. The administration's voluntary (to the banks) mortgage relief program will address only a fraction of the problem; and 12 Senate Democrats voted with the banking industry to deny bankruptcy judges the ability to modify the terms of a mortgage as a last resort - thus killing the one proposed stick in a program that is all carrots.
I also recently spoke at a convention of industrial construction companies. These are the people who build and maintain factories, power plants, and do other heavy industrial construction. I asked a room full of hundreds of executives how many saw signs of improvement in their order books. Not a single hand went up. Then I asked how many had had projects deferred because of difficulty getting financing. About two thirds of the people in the room raised their hands.
My guess is that the Obama administration will be back next fall, asking Congress for the money and authority to do the bank rescue right, after the current policy proves inadequate to restore the banking system and the economy to health. That would mean taking the insolvent banks into receivership, deciding how much public capital was required and where to get it, and then returning the banks to private ownership. Better late than never, but it's a pity to waste six months.
Chatting with the bankers in attendance at the Fed conference, mostly bankers from the heartland of the Midwest, I encountered resentment bordering on fury at the double standard. The big Wall Street banks are getting propped up with literally trillions of dollars in aid from the Treasury and the Federal Reserve, while community bankers that stuck to their knitting and did not go in for the sub-prime swindle are suffering collateral damage. That's a pun, by the way.
Because of the huge losses to the FDIC's insurance fund, small and medium sized healthy banks are having to pay increased premiums. And while the Fed and the Treasury are being extremely gentle in letting the big money-center banks like Citi value their distressed securities with great charity and forbearance, the community banks are having their loan portfolios examined with fine-tooth combs. With regulators breathing down their necks, and fewer sure-thing businesses in a position to borrow, the community banks are being made to raise their lending standards, contributing to the vicious circle of reduced business activity and reduced credit.
Why had the administration made this perverse alliance with Wall Street, and decided to prop up large zombie banks rather than taking them into receivership and getting on with it? You could blame it on campaign finance, or you could blame it on the quirk of history that Obama, once he became the nominee, decided to hire the Wall Street-oriented Clinton economic team.
The most hopeful and elegant theory I've heard is that for now, Obama's main political project is to let the Republicans self-destruct; co-opting Wall Street (for now) is part of that game plan. He'll get around to reforming Wall Street next year. Even Roosevelt had to take things one step at a time, as public opinion moved. The Second New Deal was more radical than the first. I've often said that Obama is smarter than I am, and if he is politically shrewd enough to have come up with that strategy, hats off to him. I'm also a Red Sox fan, and anything is possible. But for the moment, it looks more like a case of political expediency and even political capture.
I could excuse all that if the Geithner-Summers-Bernanke strategy of low-balling the scale of the banks' problems and inviting speculators to bail them out actually worked. But the greater likelihood is that the economy will tread water at best for the remainder of this year, losing both precious time and political credibility in America's heartland.
Robert Kuttner is co-Editor of The American Prospect and a senior fellow at Demos. His recent book is Obama's Challenge: America's Economic Crisis and the Power of a Transformative Presidency.
http://blogdredd.blogspot.com/2009/05/life-in-ferengi-home-world.html
The government will need at least 4 trillion dollars to keep the banks floating - FDIC pulled in a trillion already and we are determined to keep the banks going... only another 3 trillion and we shall be back to ground zero.
Homes will be valued at 30% of their bubble value, and another 2 trillion will be lost in the stock markets.
All pension funds are bust.
http://www.huffingtonpost.com/kevin-phillips/the-tricky-2009-politics_b_174887.html
The stock market bubble, of course, burst in the Spring of 2000, when Clinton was still president and Summers was treasury secretary. Rubin, in turn, was busy helping guide Citigroup to its contemporary disrepute.
Perhaps Obama doesn't understand this. Perhaps he does, but counts on the public not to remember (indeed, most voters probably don't). Neither explanation is cheering.
Early evidence of an unacknowledged Wall Street partnership strategy came when the new president named Clinton's chief fundraiser and late 1990s White House political director, Rahm Emanuel, as Obama's own White House chief of staff. Earlier this decade, Emanuel spent several years as an investment banker (managing director) at Wasserstein Perella in Chicago where he made $16 million arranging deals between politically-connected utilities. He also served as a director of the Chicago Mercantile Exchange. Emanuel understands how finance has been shifting its national political donations towards the Democrats.
President Obama is by no means either a Socialist nor a Communist. It grinds our leftish teeth, but, at least, he's not a fascist or a Republican. I think saving the big banks only papers over the problems so they have to break out again. Presidents do acquire greater effectiveness as their administrations wear on. I believe in his intelligence and good intentions.
http://www.pbs.org/moyers/journal/04032009/watch.html
Larry Summers is technically competent in part of the field of economics but with too narrow a perspective to fight and win the war at hand, and not humble enough to realize that he needs help. Institutions too big to fail should not be resuscitated, now or even next fall. Instead, they should be broken into pieces small enough to succeed or fail strictly on competitive merits. Also, obstacles should be placed in the way of re-growth that even approaches too big to fail, so that poorly managed large banks cannot dominate better managed small ones simply due to the advantages of scale.
As far as :too big to fail" I don't understand the lack of emphasis on getting smaller banks better capitalized under a program less onerous for management than what the big banks have.
It seems that the real leverage for hiring, and for loans to small businesses is through the smaller banks.
Perhaps it's just a question of timing.
Or perhaps it's because of Summers. I think he has the intellect to do differently, but he obviously doesn't have the psychology to question his assumptions. So far, in his eyes, he is looking like a Nobel winner for preventing a world wide financial collapse.
The advantages of scale usually give poorly run large organizations overwhelming competitive advantages over much better managed small organizations..... size masks incompetence and creates a promotion system through middle management based on competitive butt kissing rather than success in the organization's competitive market. Leaders in startup companies succeed or fail through their organizations.
It seems as if the primary objectives of preventing systemic failure and getting the economy to stop fallihg have over-ridden everything else. Then track it, how fast is the economy coming back. How much money can the banks raise privately. As the banking industry contracts, who are the real winners and losers, given the help they have all received in one way or another.
I think Obama and the Fed are pledged to a much more regulated financial industry, more evolution than revolution. Eventually, regulation in and of itself will cause the industry to shrink. I think today's action in the financial stocks is a recognition of winners and losers, and a reality check on how the institutions will acually earn money.
If I could name one pressure point, it would be the separation of investment banking and commercial banking. Even given all the other problems, it seems that the inherent conflicts of interest in government gauranteed banks playing in other fields is the root of our problems.
Go figure.
But...
The financial markets are not the same as the nation's economy. Unemployment presents a ghastly picture. Zombie banks and federal deficits are ready to suck all credit out of the system, and the entire global economy seems to be going down the drain. Depending on China is a foolhardy endeavor - the Chinese have better things to do than bail out their strategic rivals.
Geithner and the Fed should have pushed for a Swiss model to solve the banking crisis. It's been done before, with the S&Ls. Also, the nature of investment banking as a business model (balancing intermittent dribbles of inbound cash-flows from deals with short-term loans) does not lend itself easily to a publicly listed company. It's far more suitable for a partnership firm, which is how it once used to be. Sigh.
I guess the best model to follow is that of the Silicon Valley startups, or even the hedge fund industry. Small, agile. Fails quickly, with minimal load on the markets.
When I hear the dark side disaster warning people talk they cite actual numbers, studies by neutral parties, and first hand experience in the real world.
I voted for Obama and like Mr. Kuttner I think he's smarter than I am. CERTAINLY he's a better political animal than I ever could be. But right now I've got zero faith in his administration in an increasing number of areas with finance being first among them.
I haven't been this sure my government was lying to me since the run up to the Iraq invasion.
Obama, Bush, Democrats, Republicans, the Fed, Regulators................ ALL OF THEM ARE CORRUPT.
This is a battle between the American people..........ALL THE AMERICAN PEOPLE............versus the criminals who have taken over our country.
Until there is government paid-for political campaigns, at local, state, and federal, all elections including primaries, all candidates will be those pre-approved by business and the wealthy.
For middle-class McCain contributors: you don't think *YOU* contributed to Obama's campaign? Guess again, every consumer in America contributed to both candidates' campaigns. Your contribution is hidden in the price of everything you buy. And you don't even get a income tax deduction. Ain't you the perfect fool.