It is a remarkable time. On Friday, the Washington Post ran a front-page story titled, "The End of American Capitalism?" Today, the banner headline is, "U.S. Forces Nine Major Banks to Accept Partial Nationalization."
There's no question that this morning's announcement from the Treasury Department, Federal Reserve and Federal Deposit Insurance Corporation (FDIC) is remarkable.
It was also necessary.
Over the next several months, we're going to see a lot more moves like this. Government interventions in the economy that seemed unfathomable a few months ago are going to become the norm, as it quickly becomes apparent that, as Margaret Thatcher once said in a very different context, there is no alternative.
That's because the U.S. and global economic problems are deep and pervasive. The American worker may be strong, as John McCain would have it, but the "fundamentals" of the U.S. and world economy are not. The underlying problem is a deflating U.S. housing market that still has much more to go. And underlying that problem are the intertwined problems of U.S. consumer over-reliance on debt, national and global wealth inequality of historic proportions, and massive global trade imbalances.
Although it was enabled by deregulation, the financial meltdown merely reflects these more profound underlying problems. It is, one might say, "derivative."
Nonetheless, the financial crisis was -- and conceivably still might be -- by itself enough to crash the global economy.
Today, following the lead of the Great Britain, the United States has announced what has emerged as the consensus favored financial proposal among economists of diverse political ideologies. The United States will buy $250 billion in new shares in banks (the so-called "equity injection"). This is aimed at boosting confidence in the banks, and giving them new capital to loan. The new equity will enable them to loan roughly 10 times more than would the Treasury's earlier (and still developing) plan to buy up troubled assets. The FDIC will offer new insurance programs for bank small business and other bank deposits, to stem bank runs. The FDIC will provide new, temporary insurance for interbank loans, intended to overcome the crisis of confidence between banks. And, the Federal Reserve will if necessary purchase commercial paper from business -- the 3-month loans they use to finance day-to-day operations. This move is intended to overcome the unwillingness of money market funds and others to extend credit.
But while aggressive by the standards of two months ago, the most high-profile of these moves -- government acquisition of shares in the private banking system -- is a strange kind of "partial nationalization," if it should be called that at all.
Treasury Secretary Henry Paulson effectively compelled the leading U.S. banks to accept participation in the program. And, at first blush, he may have done an OK job of protecting taxpayer monetary interests. The U.S. government will buy preferred shares in the banks, paying a 5 percent dividend for the first three years, and 9 percent thereafter. The government also obtains warrants, giving it the right to purchase shares in the future, if the banks' share price increase.
But the Treasury proposal specifies that the government shares in the banks will be non-voting. And there appear to be only the most minimal requirements imposed on participating banks.
So, the government may be obtaining a modest ownership stake in the banks, but no control over their operations.
In keeping with the terms of the $700 billion bailout legislation, under which the bank share purchase plan is being carried out, the Treasury Department has announced guidelines for executive compensation for participating banks. These are laughable. The most important rule prohibits incentive compensation arrangements that "encourage unnecessary and excessive risks that threaten the value of the financial institution." Gosh, do we need to throw $250 billion at the banks to persuade executives not to adopt incentive schemes that threaten their own institutions?
The banks reportedly will not be able to increase dividends, but will be able to maintain them at current levels. Really? The banks are bleeding hundreds of billions of dollars -- with more to come -- and they are taking money out to pay shareholders? The banks are not obligated to lend with the money they are getting. The banks are not obligated to re-negotiate mortgage terms with borrowers -- even though a staggering one in six homeowners owe more than the value of their homes.
"The government's role will be limited and temporary," President Bush said in announcing today's package. "These measures are not intended to take over the free market, but to preserve it."
But it makes no sense to talk about the free market in such circumstances. And these measures are almost certain to be followed by more in the financial sector -- not to mention the rest of economy -- because the banks still have huge and growing losses for which they have not accounted.
If the U.S. and other governments are to take expanded roles in the world economy -- as they must, and will -- then the public must demand something more than efforts to preserve the current system. The current system brought on the financial meltdown and the worsening global recession. As the government intervenes in the economy on behalf of the public, it must reshape economic institutions to advance broad public objectives, not the parochial concerns of the Wall Street and corporate elite.
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