On January 21, in an abrupt change of policy, President Obama announced his intention to take on the big bankers who have brought us so much trouble. “If these folks want a fight, it’s a fight I’m ready to have,” he said with a clenched jaw at a press conference.
The government response to the financial crisis has been a spectacular success for the financial industry. Big banks are now solvent—on paper at least—and have returned to paying bonuses that strike most Americans as, well, vulgar. Their recovery stands in sharp contrast to the millions still trapped in mortgages that they cannot afford.
In a year when the government enacted one of its largest-ever stimulus bills, guaranteed hundreds of billions of dollars in bank debt, bought hundreds of billions more in mortgage-backed securities, took 60 percent ownership of one car company and put up billions in financing for another, it’s not obvious why you’d dwell on an initiative that basically cost nothing. I nonetheless submit to you that the government’s stress tests—an eight-week effort to vet the balance sheets of the country’s biggest banks—was the single most consequential economic policy of 2009.
Senator David Vitter submitted one of my questions to Federal Reserve Chairman Ben Bernanke, as part of his reconfirmation hearings, and received the following reply in writing (as already published in the WSJ online):
Q. Simon Johnson, Massachusetts Institute of Technology and blogger: Andrew Haldane, head of financial stability at the Bank of England, argues that the relationship between the banking system and the government (in the U.K. and the U.S.) creates a “doom loop” in which there are repeated boom-bust-bailout cycles that tend to get cost the taxpayer more and pose greater threat to the macro economy over time. What can be done to break this loop?
A. The “doom loop” that Andrew Haldane describes is a consequence of the problem of moral hazard in which the existence of explicit government backstops (such as deposit insurance or liquidity facilities) or of presumed government support leads firms to take on more risk or rely on less robust funding than they would otherwise. A new regulatory structure should address this problem. ... In particular, a stronger financial regulatory structure would include: a consolidated supervisory framework for all financial institutions that may pose significant risk to the financial system; consideration in this framework of the risks that an entity may pose, either through its own actions or through interactions with other firms or markets, to the broader financial system; a systemic risk oversight council to identify, and coordinate responses to, emerging risks to financial stability; and a new special resolution process that would allow the government to wind down in an orderly way a failing systemically important nonbank financial institution (the disorderly failure of which would otherwise threaten the entire financial system), while also imposing losses on the firm’s shareholders and creditors. The imposition of losses would reduce the costs to taxpayers should a failure occur.
This answer misses the central issue. Haldane’s argument (and our point) includes “time inconsistency”--i.e., you promise no bailouts today but, when faced by an awful crash, you provide a massive set of bailouts. There is nothing in Mr. Bernanke’s statements, here or elsewhere, that addresses this concern.
Before I answer that question, let me recommend Mike Grunwald's excellent cover story for the Person of the Year issue. It's a great introduction to Bernanke for readers who aren't economics or finance nerds, but you'll find it compelling even if you are such a person. I especially agree with Grunwald's verdict on Bernanke as crisis-manager:
None of this was pretty, and reasonable people can disagree about the judgment calls. The Fed is supposed to lend only against safe collateral; the Bear and AIG deals clearly crossed the Rubicon into risk. Letting Lehman fail nearly croaked the global economy. Saving AIG — an insurance company! — the next day seemed strangely inconsistent. Maybe the Fed could have devised a way to restrict bonuses at rescued firms while giving creditors haircuts. Maybe TARP could have required bailed-out banks to lend more. Certainly, all the interventions created moral hazard, sending a perverse message that "too big to fail" financial firms will be rescued no matter how badly they screw up, encouraging Wall Street traders to start gorging on risk again.
But that's what happens in panics when leaders actually try to preserve the financial system. The central bankers of the 1930s avoided moral hazard but betrayed the world. ... Now that the fire is out, it's easy to attack the firefighters for getting the furniture wet or holding their hoses improperly. [emphasis added.]
There was one sure way to not be overly-generous to fat-cat bankers, and that was to let them fail. Unfortunately, that would have also collapsed the supply of money and credit, which happens to be a sure-fire way to create a Depression. Conversely, if you're determined to prevent a Depression, then there's no way to do it without being overly-generous to the fat-cats, at least when you have the collection of too-big-to-fail institutions we had last fall. Now that doesn't mean you don't reform the system to avoid ending up there again. But those were the choices we actually faced. Given that, it's hard to believe anyone would have preferred that Bernanke make a different call.
Having said all that, should Bernanke have been person of the year in 2009?
It's hard not to be somewhat encouraged by the announcement that Bank of America has reached a deal with Treasury to repay the $45 billion in "exceptional assistance" it received last fall and winter. BofA was one of two problem megabanks (the other being Citigroup) to receive such a mega-bailout, and at times looked like it would be years before it returned the cash.
So far the members of Congress who think the Treasury Secretary should go don't quite constitute a full-blown caucus, much less anything resembling a majority. But they're expressing their opinions with increasing passion. Early this month Democratic Senator Maria Cantwell confessed that she was "not sure" why Geithner still had his job given his too-soft treatment of Wall Street. (A spokesperson later walked back the implication of that statement.) Then, last week, Geithner took some lumps from both Democrats and Republicans in the House. Oregon liberal Pete DeFazio proclaimed that Geithner should resign over his refusal to answer questions about the AIG bailout. At a hearing of the Joint Economic Committee the following day, Texas GOPer Kevin Brady told Geithner that "[T]he public has lost all confidence in your ability to do the job" and pleaded, "For the sake of our jobs, will you step down from your post?"
And the risks for Geithner only appear to be growing on Capitol Hill. Someone who recently attended a large gathering of House Democrats told me last week that "there were moments when it turned into a pep rally against Geithner and the Obama economic team."
The criticism of Geithner is threefold: First is the continued taint of AIG, whose bailout he orchestrated as president of the New York Fed. The recent report by Neil Barofsky, the special inspector general for the bank bailout (aka TARP), has reignited suspicions that Geithner and the Fed pumped taxpayer money into the cratering insurance company in order to funnel billions of dollars to its major counterparties--banks like Goldman and Merrill Lynch. The second criticism is related to the first--that Geithner is too close to Wall Street generally. This comes partly from his role in the bailouts of Citigroup and Bank of America, partly from his decision to help investors buy the banks' toxic assets rather than nationalize them, and partly from revelations about conversations he had with the CEOs of Goldman and Citi at the height of the crisis. Third, both of these problems have been magnified by the rising unemployment rate and the perception that Geithner is more concerned with the deficit than with job growth.
On the merits, I think these criticisms are all slightly off the mark.
Pity the pay czar. When Ken Feinberg announced last month that he would slash pay at seven firms that received federal bailout funds and convert large chunks of compensation to stock units that can’t be sold for years, he was met with almost universal opprobrium. Critics of Wall Street protested that simply paying out salaries in stock rather than cash would have little effect on executives at the bailed-out firms, to say nothing of the banking culture at large.
Just when our biggest banks thought they were out of the woods and into the money, the official consensus in their favor begins to crack. The Obama administration’s publicly stated view--from the highest level in the White House--remains that the banks cannot or should not be broken up. Their argument is that the big banks can be regulated into permanently low risk behavior.
In contrast, in an interview reported in the NYT this morning, Paul Volcker argues that attempts to regulate these banks will fail:
“The only viable solution, in the Volcker view, is to break up the giants. JPMorgan Chase would have to give up the trading operations acquired from Bear Stearns. Bank of America and Merrill Lynch would go back to being separate companies. Goldman Sachs could no longer be a bank holding company.”
Volcker may not have the ear of the President (as the NYT points out), and Alan Greenspan--also arguing for bank breakup, but along different lines--might also be ignored. But watch Mervyn King closely.
One thing you can't help noticing when you read about third-quarter bank earnings is the huge divide between banks whose revenue depends heavily on trading and investment banking (underwriting, M&A, etc.) and banks whose revenue depends heavily on consumer lending.
Simon Johnson raises a fair question in response to this AP scoop about the bankers Tim Geithner was in touch with early in the Obama administration. Here's the AP:
The calendars, obtained by the AP under the Freedom of Information Act, offer a behind-the-scenes glimpse at the continued influence of three companies -- Citigroup Inc., JPMorgan Chase & Co. and Goldman Sachs Group Inc. ...
In the first seven months of Geithner's tenure, his calendars reflect at least 80 contacts with Blankfein [of Goldman], Dimon [of JP Morgan], Citigroup Chairman Richard Parsons or Citigroup CEO Vikram Pandit. ...
Treasury has a huge financial stake in North Carolina-based Bank of America Corp., but CEO Ken Lewis appears on Geithner's calendars only three times. Morgan Stanley CEO John Mack also appears three times.
Bank of America and the SEC were blasted on Monday in a ruling issued by a Federal District Judge. The two parties had proposed a settlement deal over bonuses that had been paid to Merrill Lynch last year. The judge, Jed Rakoff, not only rejected it; he criticized the ethics of the proposal:
"the proposed Consent Judgement is neither fair, nor reasonable, nor adequate. It is not fair, first and foremost, because it does not comport with the most elementary notions of justice and morality,"
The entire (shockingly bold) ruling has been posted below. It's worth reading:
In the wake of the mortgage meltdown, state attorneys general have investigated predatory lending practices and brought major lawsuits against lenders and investment banks that securitized mortgages. Here’s a rundown of the biggest crackdowns and what they’ve achieved.
On March 15, Treasury Secretary Tim Geithner and a top lieutenant named Lee Sachs were summoned to the Roosevelt Room for a three o'clock meeting with the president and his chief advisers. For Team Obama, early March had been the psychological low point of the financial crisis. The Dow had sagged to a post-crisis nadir of 6440, with the stock prices of banks like Citigroup and Bank of America stuck in remainder-bin territory.
Hank Paulson's testimony yesterday was informative, if only because it illustrated that he himself still understands little about the origins and nature of the global crisis over which he presided. Perhaps his book, out this fall, will redeem his reputation.
