breaking the bank

Banks, Government and the Financial Crisis

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  • Obama's Options »
  • "Once the Word 'Nationalization' Gets Around..." »
  • Barney Frank On the Word "Nationalization" »
  • Calibrating Government's Role »
  • Stephen Labaton
  • Simon Johnson
  • Charles Duhigg
  • Paul Miller
  • Joe Nocera
  • Richard Shelby
  • Jeb Hensarling
  • Elizabeth Warren
  • PODCAST
  • Podcast: Michael Kirk & Simon Johnson
    FRONTLINE producer Michael Kirk takes listeners behind closed doors to the dramatic moment Treasury’s Henry Paulson forces nine major banks to accept $125 billion in government funding. And economist Simon Johnson talks about this step towards "nationalization," the challenges ahead, and what the U.S. can learn from other countries.

Stephen Labaton The New York Times

Banks are being told not to evict people. Banks are being told to rearrange mortgage requirements for certain people. Banks are being told to extend more commercial credit. Banks were told in the last round of legislation that if they lay people off, they can't hire people with visas who are not American citizens. Banks are being told to curtail their executive compensation. Banks are being told that shareholders should have a right to vote on compensation.

Slowly and surely the government is, for better or worse, getting more involved in the daily lives of institutions' receiving money. You can call that whatever you want. You can call that the beginnings of nationalization; you can call it more regulation. But at the end of the day, the more banks receive from the federal government, the more the federal government is going to get involved in the way they do their business.

Of course, there are many people who say: "Well, what's wrong with that? That sounds pretty good, because the banks got us in this trouble." But the other side of that story is what?

The other side of that story is, are we creating hundreds of little Fannie Maes and Freddie Macs [Federal National Mortgage Associations and Federal Home Loan Mortgage Corporations] out there that have a conflicting mission -- on the one hand to do what the federal government wants to do and [on the other hand] to return maximized profits to the shareholders? And when they have both mandates to the government and to the shareholders, can they continue to make money and be profitable and also serve those orders, demands, requests that are made by the government?

And those orders, demands, requests are about social policies.

Social and economic policy. The fear among the critics, if you talk to them, is that many banks, particularly weak banks, can't do both, and that rather than just taking out the unhealthy banks and cleansing the system, you are in effect weakening the system, weakening the stronger banks, keeping the zombie banks alive by having a policy that, rather than taking out those banks, uses those banks to effectuate economic and social policy.

Simon Johnson Former chief economist, International Monetary Fund

I think we'll wake up one day and there will be a story in the paper that says, "Oh, by the way, the Fed now provides essentially, one way or another, 70, 80, 90 percent of the credit in the U.S. economy." And we're going to be, "Oh, how did that happen?"

That's nationalization of the credit system. Even though you haven't nationalized ownership of the banks, the Fed becoming more important as a driver and the provider of commercial credit is the same thing. ...

The idea that the Federal Reserve has become a commercial bank, what's the story there? ...

The Federal Reserve becoming a commercial bank is, like all really big transformations, something that happens, or happened, incrementally. ...

I remember after the Bear Stearns deal, they announced a facility -- I honestly don't remember the acronym anymore because we've been through so many permutations -- they announced a facility that I believe was a 90-day term. ... And of course, here we are a year later, and [there's been] some mixture [that] extended it and expanded it and changed the acronyms. Forget the acronyms -- the Fed is providing a massive amount of credit directly to the economy.

Now, I'm not saying they should withdraw that; I'm not saying it's a bad thing. But I'm saying it's a new thing, and I'm saying the Fed is your banker, increasingly, for many American households and companies. And sooner or later it will have to disengage from that, and that's going to be difficult.

Because?

Because if the Fed really is the banker to everyone and for everything, then the chairman of the House Financial Services Committee is the owner or controller or overseer of your banker. And he or she, whoever it is at that time, even the best possible person -- I have a great deal of admiration for [House Financial Service Committee Chair Rep.] Barney Frank [D-Mass.], for example, who's in that position; has done a great job I think, so far -- it's just too tempting for politicians to be involved in banking.

When politics and banking get mixed up, when the politicians decide who gets a loan, it always goes badly everywhere in the world. Why should the U.S. be any different?

Charles Duhigg The New York Times

When people talk about this in the past, what they say is, "Well, the last time we did this was in the Great Depression in the 1930s." And it worked. The government took over the banking sector, and they basically got the houses in order, and then they reprivatized those banks; they sold them to shareholders again, and the American public actually ended up making money on the deal. ...

But there is a cost associated with nationalizing the banks, even a soft nationalization where we just take majority ownership, and they're still technically private. ...

All systems of innovation, all systems of growth and expanding the pie are based around finding people who are willing to take the risk to do it. Banks are at the core of that. They are basically machines that make decisions between risk and reward. But when the government runs the bank, they're solely focused on avoiding risk. There's no upside for them pursuing the reward.

And that's what we saw during the Great Depression. The banks continued operating, they got stable again, they did a good job of helping people buy homes and not bankrupting the nation, but they didn't take a lot of the risks that push innovation. And for whatever the failings of the last 20 years -- and there are many, and we're living through them right now -- in the last 20 years, America has been more innovative than certainly any other nation and probably more innovative than any time since the mid-1800s.

Paul Miller Financial Analyst, FBR Capital Markets

I for one have been a proponent of what we call "closed-bank" solutions. And closed-bank solutions [are] what we did in the late '80s -- you go into a Citi, you take the bad assets, put it on the government's balance sheet, and you sell off Citi to private investors, and you try to do it as fast as possible -- versus what we call "open-bank" assistance, which we're doing now: You keep the manager in place; you keep the shareholders intact. You might dilute them, but ... you either put money [in] or you backstop assets to keep the bank up and around and floating, but you really don't fix the real problems.

Historically, open-bank assistance programs have not really worked that well. Closed-bank solutions, where you close the bank down, have been the choice over time and have worked very, very well. But now we wake up in 2008; these institutions are so big, would a closed-bank solution work?

[Former Federal Deposit Insurance Corp. Chair] Bill Seidman, he was the guy that really pushed the system back in the late '80s, closing down banks. He started RTC [Resolution Trust Corp.], ran RTC. He said Citi would be no problem. Bill Isaac -- he's the head of the FDIC in the early '80s; ... he closed down Continental Illinois; it took seven years to deal with it, a lot of manpower, never really dealt with it well -- said that if you think Continental Illinois is bad, wait until the government goes in and does Citi.

So there [are] two very well-known men who tell you there's two different ways to approach this problem. So that's why if you're the government, if you're [Secretary of the Treasury Tim] Geithner, and you're Obama, and you listen to all these inputs, which direction do you take?

The easiest solution is just to pump money into the banks and then see if you can't earn through it. And that's what they're trying to do. They're saying let's nationalize them but not call it nationalization. Let's support them; let's guarantee the debt; let's guarantee the deposit; let's guarantee the liquidity, and put more money into it to make the shareholders happy so it doesn't fail. And hopefully we can baby-sit these guys through the crisis, and on the backside, they don't have to pay us back. But you know what? We all lived.

That's the approach they're taking. But the problem is the holes are too big. There's a big assumption that they can earn through the problem. And if they can't earn through the problem, we're just going from crisis to crisis to crisis to crisis. What we've said is the problem with this solution is you just jump from crisis to crisis to crisis, and all of a sudden you're waking up and you haven't fixed anything; you just cause a lot of headaches.

Of all the money we put into Citi, of all the programs we've had for the last two years to solve the housing crisis, we wake up, and Citigroup is trading at $1.02.

Joe Nocera The New York Times

It's incendiary, because the word "nationalization" implies socialism, and that has all kinds of political consequences. But basically, the FDIC nationalizes banks all the time. They take them over; they strip out the bad assets; they fire the management; they bring in new management, and they sell off the good banks to some private investor. It's more complicated, it's more difficult, but there's no reason that can't be done to a big, money-center bank. …

The argument against nationalization has always been that we are a country that believes in a system of shareholders and debt holders and private ownership, and that this is a slippery slope, and that these entities are so large and so complicated that it wouldn't be a quick six-month, four-month, FDIC-type takeover; it would be something that would last for years and years and years. And it would be very, very hard for the government to kind of get out of it without losing a ton of money for the taxpayers -- perfectly legitimate complaint, by the way -- and that you won't attract private money.

But I don't believe that's true. I believe that nationalization will allow you to attract private money, precisely because you'll know where the bottom is. ... And once you know where the bottom is, that's when private capital will come back in.

Richard Shelby Ranking member, Senate Banking Committee (R-Ala.)

You've got a situation now where the government's role is greater in markets and in banks than at any time since the Great Depression. Is that a problem?

It's a problem. Some people would say, "Gosh, this is the only game in town right now," the government putting money, putting capital into some of our largest banks. But it wasn't the only game in town. There's probably trillions of dollars in private money sitting on the sidelines right now, looking for a good investment. But they're not buying bank stocks yet because they don't trust the banking system. And we've got to resurrect that, and it's not going to be easy. ...

I think you have to let things fail. There should not be a guarantee in the marketplace. The market will decide who makes it and doesn't make it. And if we regulate institutions the right way, we should tell them that at the beginning, that we're not going to bail you out. We're not going to inject billions and billions of dollars, or maybe trillions, of taxpayers' money to keep you going. ... I think that's the road they're going down, and I think it's the wrong road. ...

People have got to believe in the banking system and our monetary system. They've got to believe, because it's all predicated on trust. And right now, there's a lack of it in this country. And the reason banks aren't really loaning to each other yet is they don't trust. We've got to make sure that our banking system is viable, because without the banking system, we're in one heck of a shape.

Jeb Hensarling U.S. House of Representatives, (R-Texas); Member, TARP Congressional Oversight Panel

I can assure you, you do not want Congress to be in the business of allocating credit in the United States of America. It's frankly what helped bring us to the economic turmoil in the first place. When you look at the actions of the government-sanctioned duopoly of Fannie Mae and Freddie Mac, and when you look at the Community Reinvestment Act that essentially, no matter how noble its intention was, told banks to bring down their lending standards as opposed to bringing up the economic opportunities of the borrowers, we know that was a recipe for disaster. ...

One of the things the market needs is certainty: Tell us what the policy is. There is so much capital sitting on the sidelines that the administration could employ. They can't act not knowing the prevailing winds of Washington, because every day they're thinking: "Is Washington going to bail me out? Is Washington going to bail my competitor out? Is Washington going to bail my customer out? How can I actually [know what the policy is] when the winds blow from every single direction in Washington?" We need certainty of policy, and we have not received that from the administration. ...

Elizabeth Warren Chair, TARP Congressional Oversight Panel

Now we have a public-private mix that is the most dangerous of all. It's neither the due north that said, "Hey, it's your problem; the losses fall where they fall," nor is it a due south: "We'll prop you up by giving you cash to do your operations and make your business work." This has now entered a very different realm.

This is the realm of the puppet master. This is the realm of the "We're going to give you some money, but we're also going to tell you how to run the game." And I don't mean just run the game for your own financial security, like stop with the corporate jets and stop paying your CEOs zillions of dollars; I mean how you're going to run the game as in, you're no longer running it even to save your own business. You're going to run it to fit our larger policy, because we don't want this other company to fail, so you will become the instrument of the bailout.

Now, the interweaving of government and private at a decision-making level, at a national policy level, that takes all of this out of public debate. I mean, let's just be clear here, right? The idea that this is an open public process, that we're going to kind of announce what we're trying to do, ... that's totally gone. This is, "I'm going to pull the strings; I'm going to make it happen a certain way and use this bank as an instrument of some kind of plan to try to save this economy."

Social and domestic policy being enacted out from a kind of central bank.

From someone who has no legal authority to do this; from someone who's not an elected official; from someone who's devising back in the shadows a reorganization of the American financial system and how it's going to play out, with no checks, no balances. Just the decision: "This is how I'm going to do it."

posted june 16, 2009

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