The Political Strategy for Bank Recapitalization Emerges

by: The Baseline Scenario

By Simon Johnson

Here’s a tough problem.

  1. The nation’s leading banks are short of capital, and only the government can provide the scale of resources needed to recapitalize, clean up balance sheets, and really get the credit system back into shape. Any sensible approach will put some trillions of taxpayer money at risk. We should get most of it back but - as we’ve learned - things can go wrong.
  2. Everyone hates bankers right now, and these feelings only deepen as we learn more about how the first part of the TARP was spent and misspent. No one wants to hear about anything that sounds like a bailout to bankers and their careers.

How does the Administration and Congress sort this one out? This weekend we were seeing an approach take shape which, most likely, will work. There are five closely related moving pieces.

First, there will be an immediate clamp down on regulated banks and hedge funds. This will be popular. By itself, of course, it brings some dangers as pro-cyclical regulatory action is a good way to deepen a recession. But the goal here will be to flush out everyone and anyone who does not have enough capital to stay in business. This makes good economic sense and it will build support for the idea that this Administration can be tough on the financial sector while also turning it around.

Second, the fiscal stimulus will pass soon. This will be widely popular, particularly as there is something for almost everyone in the short run.

Third, some of the TARP II money will go into a program for refinancing housing. I expect this will run to $100bn+ (likely leveraged to a higher headline number) and will get broad support; who can really resist trying to break the death spiral of house prices, foreclosures and forced sales? Tim Geithner will probably announce the broad contours within a day or two of being confirmed - in part because it also makes the point that the remaining $200bn or so in TARP II will not be enough to recapitalize and clean up the banking system properly.

Fourth, we will begin to understand that our intervention in the banking system is not nationalization but rather taxpayer participation in the upside gains from the impending recovery. Here is the right way to begin selling this:

“If we are going to put money into the banks, we certainly want equity for the American people,” said Pelosi, a California Democrat. “If we are strengthening them, then the American people should get some of the upside of that strengthening. Some people call that nationalization; I’m not talking about total ownership, but we’re just saying.” (From Bloomberg’s coverage of the House Speaker on television Sunday.)

Of course, we also need a technical solution for how the government gets in and then gets out of the banks, without becoming ensnared in a political and lobbyist quagmire. (We have proposals for this; so do others.)

Fifth, we need to have what Senator Kent Conrad emphasized today on CNN: “sufficient resources.” This is where the discussion only just begun (e.g., listen to some of Diane Rehm’s Thursday show) and where we will need to make rapid progress - probably just as soon as the fiscal stimulus is a done deal.

Did I miss anything?