I hate shooting the messenger even when he lets us know that he is a tad invested in the information he is conveying, but sometimes it is warranted. Floyd Norris now tells us that maybe it wasn’t such a good idea to have been so generous to the banks during the crisis. He cites the usual reasons: the recovery is shallow, the officialdom missed the opportunity created by the crisis to restructure the financial system, sparing bondholders created moral hazard, and we are now stuck with banks in the driver’s seat. His lament, as the headline accurately summarizes, is “Crisis Is Over, But Where’s The Fix?”
The problem is that his account is larded with a rationalization of the decisions made at the time to treat major financial firms with soft gloves:
At the time, rescuing seemed more important than reforming. The world economy was breaking down because of a lack of financing. Trade flows collapsed, and companies and individuals stopped spending. It seemed clear that halting the slide was critical…
A surprising citadel of that second-guessing is at the International Monetary Fund, where researchers this week concluded that the rescues “only treated the symptoms of the global financial meltdown.”
“Second guessing” is simply misleading. It gives the inaccurate impression that decisions made at the time are now being questioned with the benefit of hindsight. But in fact, those decisions were criticized loudly at the time by a vocal minority, including yours truly.
Even during the last window of opportunity to bring the banking industry to heel, in early 2009, when the financiers were still chastened, quite a few people, including Paul Krugman, were calling for nationalization of the sickest banks, which would have been Citigroup and Bank of America. A next best step, as many including Nouriel Roubini, advocated, was wiping out the stock and bondholders. They were the providers of risk capital; no one held a gun to their heads to buy those investments. Yes, this measure have hit smaller banks that had been encouraged by regulators to buy bank preferred stock, but that seemed a too convenient excuse for not taking on the managements of the biggest of the TARP banks).
There were all sorts of alternative approaches discussed as the crisis ground on. September and October 2008 were so gut-wrenching that it’s often forgotten that there were four acute phases, starting in August 2007. The Bagehot rule was invoked repeatedly as a guiding principle (lend freely, at penalty rates, against good collateral) and ignored. The Fed went from being behind the curve to over-reactive, as “75 was the new 25”, meaning the Fed was making sharp policy rate cute when markets got wobbly. A small minority became concerned when the Fed dropped the Fed funds rate below 2%, since it risked entering liquidity trap land with successive reductions (and indeed that is where we seem to be). Well before September 2008, there was ample discussion in econ policy circles of the Swedish response to its early 1990s banking crisis, which included throwing management of troubled institutions out, putting in new teams with clear objectives for their institutions but latitude in how to reach those goals, and setting up a vehicle to manage and work out troubled assets. The IMF even got serious about the question, but because its report on 124 banking crises was issued at the end of September 2008, things were moving too fast for it to get any consideration. Its main finding:
Existing empirical research has shown that providing assistance to banks and their borrowers can be counterproductive, resulting in increased losses to banks, which often abuse forbearance to take unproductive risks at government expense. The typical result of forbearance is a deeper hole in the net worth of banks, crippling tax burdens to finance bank bailouts, and even more severe credit supply contraction and economic decline than would have occurred in the absence of forbearance….
Cross-country analysis to date also shows that accommodative policy measures (such as substantial liquidity support, explicit government guarantee on financial institutions’ liabilities and forbearance from prudential regulations) tend to be fiscally costly and that these particular policies do not necessarily accelerate the speed of economic recovery. Of course, the caveat to these findings is that a counterfactual to the crisis resolution cannot be observed and therefore it is difficult to speculate how a crisis would unfold in absence of such policies. Better institutions are, however, uniformly positively associated with faster recovery.
So no one can credibly pretend that plenty of authorities were opposed to bailouts (as opposed to resolutions and restructurings). Yet the revisionist history is that there was unanimity on what to do, and any alternative was not feasible. We live, after all, in the best of all possible worlds, even if it does not look so hot at this particular juncture.
But the sellout and its consequences were obvious to anyone who had been paying attention. Simon Johnson’s article, “The Quiet Coup“, hit the newsstands a mere two months after the Obama administration officially threw its lot in with the bankers with the announcement of the stress test charade in March 2009.
Where were members of the economics elite in calling for a proper post mortem? Why wasn’t evey major bank who took bailout money or accessed emergency facilities made, as UBS was, to conduct an investigation and report to regulators and shareholders? Why wasn’t there a push for international cooperation and data sharing on post crisis forensics? Keeping the bankers under the microscope could have at least contained their hubris; continued focus on managerial failures and looting would have given air cover that would have resulted in less limp-wristed reforms.
As we summed up a year ago:
The case for bold action was sound. The history of financial crises showed that the least costly approach is to resolve mortally wounded organizations, install new management, set strict guidelines, and separate out the bad loans and investments in order to restructure and sell them…
This juncture [the early days of the Obama administration] was a crucial window of opportunity. The financial services industry had become systematically predatory. Its victims now extended well beyond precarious, clueless, and sometimes undisciplined consumers who took on too much debt via credit cards with gotcha features that successfully enticed into a treadmill of chronic debt, or now infamous subprime and option-ARM mortgages.
Over twenty years of malfeasance, from the savings and loan crisis (where fraud was a leading cause of bank failures) to a catastrophic set of blow-ups in over the counter derivatives in 1994, which produced total losses of $1.5 trillion, the biggest wipeout since the 1929 crash, through a 1990s subprime meltdown, dot com chicanery, Enron and other accounting scandals, and now the global financial crisis, the industry each time had been able to beat neuter meaningful reform. But this time, the scale of the damage was so great that it extended beyond investors to hapless bystanders, ordinary citizens who were also paying via their taxes and job losses. And unlike the past, where news of financial blow-ups was largely confined to the business section, the public could not miss the scale of the damage and how it came about, and was outraged.
The widespread, vocal opposition to the TARP was evidence that a once complacent populace had been roused. Reform, if proposed with energy and confidence, wasn’t a risk; not only was it badly needed, it was just what voters wanted.
But incoming president Obama failed to act. Whether he failed to see the opportunity, didn’t understand it, or was simply not interested is moot. Rather than bring vested banking interests to heel, the Obama administration instead chose to reconstitute, as much as possible, the very same industry whose reckless pursuit of profit had thrown the world economy off the cliff. There would be no Nixon goes to China moment from the architects of the policies that created the crisis, namely Treasury Secretary Timothy Geithner, Federal Reserve Chairman Ben Bernanke, and Director of the National Economic Council Larry Summers.
Defenders of the administration no doubt will content that the public was not ready for measures like the putting large banks like Citigroup into receivership. Even if that were true (and the current widespread outrage against banks says otherwise), that view assumes that the executive branch is a mere spectator, when it has the most powerful bully pulpit in the nation. Other leaders have taken unpopular moves and still maintained public support.
Obama’s repudiation of his campaign promise of change, by turning his back on meaningful reform of the financial services industry, in turn locked his Administration into a course of action. The new administration would have no choice other that working fist in glove with the banksters, supporting and amplifying their own, well established, propaganda efforts.
Thus Obama’s incentives are to come up with “solutions” that paper over problems, avoid meaningful conflict with the industry, minimize complaints, and restore the old practice of using leverage and investment gains to cover up stagnation in worker incomes. Potemkin reforms dovetail with the financial service industry’s goal of forestalling any measures that would interfere with its looting. So the only problem with this picture was how to fool the now-impoverished public into thinking a program of Mussolini-style corporatism represented progress.
Apologists for the Bush and Obama administrations’ conduct during the crisis, whether they recognize it or not, have been and continue to be part of this propaganda program.