Catastrophe (12 page)

The problem, of course, is how to remove these toxic assets from the banks’ balance sheets. The easiest option would be for home values to increase so they become nontoxic, but the recession’s unemployment and deepening economic impact rule that out.

That’s why the Federal Reserve, the Treasury, and Congress applied first aid to stop the bleeding by pouring $700 billion of TARP funds into these financial institutions to make their balance sheets look better. This is the money most of these banks and brokerage houses chose to keep in the Fed’s vault, rather than spending it as it was intended.

But better balance sheets didn’t bring liquidity. Aware that these banks were being propped up by TARP, investors stayed away from buying their stocks and bonds. Unable to raise capital, the banks never reopened their lending windows. So TARP stopped the banks from failing but didn’t do much to get the economy rolling.

All of which leaves Obama with two options:

1. Get the government and private investors to partner in buying up the toxic assets to get them off the bank balance sheets, or
   
2. Nationalize the banks and have the Treasury do it.
   

The hope that underpins both approaches, of course, is that the economy will recover, so that homes’ values will rise and their prices will become
high enough to pay off the mortgages. It is inevitable that this will happen at some point, but it could take a lot of waiting around. If the loans that are in default are on the bank balance sheets in the interim, the banks won’t lend money. But if they are wiped off and the Treasury or outside investors hold the debt while waiting for the value of the underlying properties to appreciate, the banks will be free to lend again. At least that’s how it should work in theory.

Obama says he’s betting on a public-private partnership to buy up toxic assets at a fraction of their book value and hold them until the economy turns around. Then the plan would call for them to be sold them on the open market, with the private investors and the taxpayers sharing the gains. If the plan backfires and the assets never fetch a decent price, the investors and the government will share the loss between them.

The big problem is how to induce investors to share the risk and the outlay with the government. As Treasury secretary Timothy Geithner told the
Wall Street Journal
, “government cannot do this [clean up the bank assets] alone.” Geithner notes, correctly, that “the best way to get through this [crisis] is if we can work with the markets. We don’t want the government to assume all the risk. We want the private sector to work with us.”
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The problem, as the
Journal
noted, is that Geithner’s plea for private participation comes “at a time when Wall Street moneymakers are being vilified by the public and politicians.”
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Just as with the TALF program, Obama’s plan to rescue banks will be destroyed by his own populist rhetoric. When the president jumped in with both feet and decried the bonuses paid to AIG executives, calling for congressional or Treasury action to get the money back, he may have scored political points. But in doing so he sent a chill through the financial markets—a chill that makes it unlikely that they’ll participate in any bank rescue effort. After all, if they do join in and their risk taking is rewarded, can’t you see the Democrats demanding caps on their bonuses? Won’t the government seek a larger share of the winnings—especially if the taxpayers are still left with some amount outstanding—rather than allow those rich, evil investors to make millions or even billions of dollars of profit?

The lesson of AIG is: what the government wants, the government gets. By voting a special tax on AIG bonuses, the House of Representatives
showed that, in today’s Washington, populism trumps good sense. Whether out of conviction or fear, legislators are willing to flay investors if that’s what it takes to appease the public’s bloodlust.

Since no investor wants to be the next one on the guillotine, the wisest course is to stay out of any bank rescue scheme. And, most likely, the investors will do just that.

To lure them in, Geithner has a backup plan: give away the store. His proposal for a public-private “partnership” is simple: the taxpayers take all the risk, and the private investors make all the money.

Joseph E. Stiglitz, a Democrat who was chairman of the Council of Economic Advisers under Clinton from 1995 to 1997—and who won the Nobel Prize in 2001—is an unlikely critic of Obama’s proposal, but he has it about right. He says Geithner’s proposal is a “win-win-lose proposal: the banks win, investors win—and taxpayers lose.”
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He notes that “the government would provide 92 percent of the money to buy [bank] assets, but would stand to receive only 50 percent of any gains.” And the government would “absorb almost all of the losses. Some partnership!”
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But such public largesse creates its own problems. The end result is likely to be that the taxpayers will be stuck holding a rather large bag of debts that will produce no money—as investors walk away with tens or hundreds of millions—or even billions—of dollars.

But those private investors have watched the decapitation of AIG and General Motors. They know that once House Banking chairman Barney Frank (D-MA) learns how much they made, all hell will break loose. Even though it’s his plan, Obama will lead the chorus of outrage—and Congress will respond by passing one of its 90 percent tax bills. The public anger will force them to do so.

So a lot of investors—the smart ones—will stay away.

If the Geithner plan fails, which it will, Obama will be faced with the second option: nationalization. If the feds take over the banks, they can lend money directly to consumers and businesses, just as they now do for many student loans and loans from the Small Business Administration.

Ultimately, as Obama’s war on wealth continues, it’s likely that he’ll nationalize the banks. The more he demonizes those who get big bonuses and castigates the greed of the firms that made the mistaken investments, the
more he will sap their confidence, stoke their fears, and deter them from buying up toxic assets or from new lending.

Any lingering doubt about Obama’s intentions toward the financial sector should have been dispelled on March 24, 2009, when the
Washington Post
reported that “the Obama Administration is considering asking Congress to give the Treasury Secretary unprecedented powers to initiate the seizure of non-bank financial companies, such as large insurers, investment firms and hedge funds, whose collapse would damage the broader economy.”
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At present, the government has the right to seize banks but not other financial institutions. The power the administration seeks is, literally, the ability to impose—unilaterally and without legislative approval—a socialist economy on the United States. It comes as close as anything we have seen to a legislative equivalent of the Bolshevik Revolution.

As the
Post
noted, “giving the Treasury Secretary authority over a broader range of companies would mark a significant shift from the existing model of financial regulation, which relies on independent agencies that are shielded from the political process.”
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What an understatement!

One of the proposals the administration is reportedly considering could “impose greater requirements on company boards to tie executive compensation more closely to corporate performance and to take other steps to ensure that compensation was aligned with the financial interest of the company,”
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the
New York Times
reported.

This intrusive regulation would affect not only companies that receive federal funds, but all financial-sector companies! The
Times
specifically noted that “the new rules will cover all financial institutions, including those not now covered by any pay rules because they are not receiving federal bailout money. Officials say the rules could also be applied more broadly to publicly traded companies, which already report about some executive pay practices to the Securities and Exchange Commission.”
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Even speculation that the administration is considering limits on executive pay amounts to a declaration of war against the private sector. The fact that Obama’s people leaked the story—whether or not Congress approved it—is enough to indicate that they wanted it out there.

And they leaked it during the same week that the administration was seeking private-sector cooperation in buying up the banks’ toxic assets.

Does President Obama truly believe he can lecture and castigate Wall
Street on Mondays, Wednesdays, and Fridays and still get its cooperation on the days in between?

Doesn’t he understand that when he ignites a public furor over AIG bonuses and then incites Congress to pass a punitive tax, he sends shivers down the spines of every other successful corporate executive? Does he seriously believe that Wall Street investors won’t worry that their winnings, should they join the Treasury as partners in risky investments, would be subject to public abuse, publicity, and confiscatory taxation?

Of course he realizes that his rhetoric makes it unlikely that his program will succeed. He obviously knows the entire concept of a public-private partnership is impossible in a climate of waging class warfare, taxing the rich, and heaping contempt on anyone who makes money. The president is bright; he understands that you can’t shake hands with your right while you launch a roundhouse swing with your left.

So why does Obama persist in his aggressive rhetoric? Why does he continue to treat Wall Street as something out of Dante’s
Inferno
?

Because he wants the public-private partnerships to fail—and he plans to use that failure to justify his nationalization of the banks. We believe that’s his real goal.

His intent to force a nationalization of banks is obvious in the way he is regulating banks. He is adopting rules that literally force a government takeover. Here’s how it works:

WHAT WILL HAPPEN IF OBAMA DOES NATIONALIZE THE BANKS?

In all likelihood, the federal government would be able to clean up the bank balance sheets a lot faster than the bankers can. The federal bureaucrats aren’t wed to any of the loans; their reputation isn’t involved one way or the other. They can write off debts more ruthlessly than the bankers can and can then auction them off at bargain-basement prices to bottom-feeders willing to wait for values to improve.

As many economists have pointed out, there would be little difference between outright nationalization and the current situation.

In return for the TARP bailout, the U.S. government has acquired stock in the banks it has helped. But it has been careful to buy only “preferred” shares and warrants, not common stock. (“Preferred” means that the holder gets first crack at any dividends but doesn’t get to vote on bank management). By buying preferred shares, the government was trying to keep the banks in private hands (although Washington’s leverage doubtless entitles it to push the banks around however it likes). The feds were also trying not to dilute the holdings of the current common-stock holders, to avoid hurting the value of their shares.

Of course, then the prices of bank stocks crashed anyway. Even so, nationalizing the banks would involve wiping out their investments. These beleaguered stockholders are, undoubtedly, hoping that the banks, like the South, will “rise again,” that their shares will be worth more than Confederate money. But nationalization would kill off their fantasy permanently, incurring an important political cost.

Moreover, the federal government realizes that once it nationalizes one bank, the value of all the other shares is likely to crash, out of fears that their bank might be next.

Even so, one top economist, Nouriel Roubini, who predicted our current crisis years ago, points out that “the debate on bank nationalization is borderline surreal, with the U.S. government having already committed—between guarantees, investment, recapitalization, and liquidity provision—about $9 trillion of government financial resources to the financial system (and having already spent $2 trillion of this staggering $9 trillion figure).”
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“Thus,” he adds, “the U.S. financial system is de facto nationalized. The only issue is whether banks and financial institutions should be nationalized de jure.”
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Former Federal Reserve chairman Alan Greenspan says, “It may be necessary to temporarily nationalize some banks in order to facilitate a swift and orderly restructuring.”
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(But the current Fed chairman, Ben Bernanke, said on February 25, 2009, that the U.S. government isn’t planning “anything like” a nationalization of banks, which would wipe out the stock-holders.
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)

Roubini says he’s not opposed to the idea of nationalization, as long as “you take the banks over, you clean them up, and you sell them in rapid order to the private sector.” If it’s “clear that it’s only temporary,” he could support nationalization. “No one’s in favor,” he says, “of a permanent government takeover of the financial system.”
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