Axelrod And Emanuel Were Right (On The American Bank Oligarchs)

When you cut through the technical details and the marketing distractions, sorting out the US banking fiasco comes down to one, and only one, question. How tough are you willing to be on the people who control the country’s large banks?One option is to be gentle with them and adopt only ideas that they pre-approve. This route involves complicated schemes to purchase, lend against, or otherwise “wash” toxic assets out of the banks using taxpayer subsidies. This will be expensive (for the taxpayer), messy politically, and – most likely – will not work, in the sense of restoring the banking system to something close to its normal mode of functioning; check with Hank Paulson for details.

Alternatively, you can be tough and take steps towards really assessing which banks are insolvent when you use market prices to value their assets. These banks can be taken over in a scaled-up FDIC-type procedure (no golden parachutes!), and controlling stakes in fully recapitalized banks can be sold off immediately to new private owners. The new private owners can handle, under proper anti-trust supervision, the break up the banks.  This approach will be cheaper for the taxpayer (but nothing is free at this stage), easier to explain to the electorate and their representatives, and it will work – this is in fact the standard prescription because it always works.  But it will not make powerful bankers happy.

So which way is the Obama Administration heading?  We honestly don’t yet know; the signals are mixed.

Indications that we are rolling over for the banker lobby are: (1) weak executive compensation caps, announced last week, and (2) insufficient money available or yet sought to back up the recapitalization that should follow the “once and for all” stress test of the banking system.  The math on point (2) is: there is only $320bn left from TARP, of which – we learned today – $100bn is to go in further support for the securitized credit market, $50bn for housing support (and this could end up higher), and at least $50bn for private-public toxic asset purchase/loan scheme (thi is my inference from the statement that this bank should be $500bn going on $1trn total).  The $120bn or so left over is probably not enough to recapitalize one major troubled bank, let alone the entire system.

But there are also more positive signs.  Secretary Geithner was much more critical of bankers and their compensation schemes than officials have been to date.  And President Obama is clearly angered by bankers’ arrogant bonuses. The Administration’s messages of transparency and accountability are refreshing and exactly on the mark. And I liked this line from Geithner (from CNNMoney),

“These banks need to understand that access to government resources is a privilege, not a right. It’s not for the banks. It’s for the people, and companies depend on that.”

Do the banks understand this?  Read Lloyd Bankfein’s article in Monday’s Financial Times, and tell me if you see any such indication from the CEO of Goldman Sachs.

So how do you get message across?  Obviously, we need the comprehensive stress test immediately and it has to be transparent and very tough.  And this is where David Axelrod and Rahm Emanuel have apparently been exactly right in the past 10 days.  According to press reports (NYT yesterday and WSJ last week), both have pushed for tougher symbolic and substantive actions that would hurt bankers’ pocketbooks and weaken the largest banks.

Remember, weakening the big banks and their bosses should not be seen as an unfortunate side effect of beneficial medicine.  It is exactly what we need to do under these circumstances.  Unless and until these banks’ economic and political influence declines, we are stuck with too many people who know exactly what they can get away with because their organizations are “too big to fail.”

And weakening these banks (or actually having some of them go out of business and be broken up) as part of a comprehensive system reboot – with asset revaluations at market prices and a complete recapitalization program – will help return the credit system to normal.

For reasons that are not obvious, Axelrod and Emanuel have not prevailed on the degree of toughness towards the American Banking Oligarchy.  But this may change.  Let us hope it is soon.


Originally published at the Baseline Scenario and reproduced here with the author’s permission.