U.S. Handling of Financial Crisis - A Less Optimistic View

The Obama Administration is captured. To understand why it has acted as it has, one doesn’t have to take the view that its efforts to save the banking industry were a deliberate attempt to line bankers’ pockets by transferring money from taxpayers to the banking industry. One need merely read the last post I wrote on this topic.

In their wildly optimistic view, the banking industry is solvent and always has been. All that was needed to ‘solve’ the banking crisis was a lot of liquidity, government backstops and, most importantly, time. This blinkered view sees a looting of taxpayer money to bailout the banking industry as necessary to save banks whose credit is the ‘lifeblood of our economy.’

They are wrong. The banks did not need to be bailed out. The banking industry needed to be made solvent again. There is a big difference between those two sentences (banks versus banking industry and liquidity versus solvency) that goes to the core of the captured and politically damaging world view we have seen on display by the Obama Administration.

Change you can believe in

Think back some 18 months when Senator Obama was in a horse race with Hillary Clinton to see who would go up against John McCain in the Presidential election. If you asked any reasonable individual who had the least experience and the thinnest political resume of the three, he or she would have said Barack Obama. If Americans wanted someone long on inside-the-beltway experience, they would have chosen John McCain – or, at a minimum, Hillary Clinton, not Barack Obama.

So, Barack Obama did not best both Hillary Clinton and John McCain and get to the White House because Americans felt him more qualified for the job. Rather, Americans believed the U.S. was on the wrong path and wanted a qualified person to lead the country who would also change course. They believed that person was Barack Obama.

And when it came to the economy, the presence of two men, Paul Volcker and Warren Buffett, born some 80 years ago, gave one the sense that, despite Barack Obama’s perceived relative youth or inexperience, he had the ablest of wise old men who would be his and our counsel in resolving this crisis.

Bailing out the banks

So when Barack Obama took office, it came as a rude awakening for many that he chose to bail out the too big to fail institutions with little or no strings attached, allowing them to later make record profits and pay record bonuses, while the economy was in a deep slump and ordinary Americans were being bankrupted and losing their jobs and homes at record rates. This was not change you can believe in.

What could or should the Obama Administration have done?

If you had listened to the chatter inside the beltway early this year, you would realize that Obama’s team believed it was not politically feasible to ‘nationalize’ Citigroup (C) or Bank of America (BAC) and force top executives to resign as was done at RBS, Bradford and Bingley or Northern Rock in the UK. This was a blinkered view which can only be described as captured (if not outright disingenuous). We need look no further than Fannie Mae (FNM) and Freddie Mac (FRE) to see that nationalization was an option.

But this is not the kind of solution we needed. What we needed was a solution by the Administration to take prompt corrective action in seizing bankrupt institutions, dismissing management, punishing any misdeeds and setting up a timetable to sell off the institution’s assets. That is change you can believe in.

I laid this out fairly comprehensively in February in my post “America needs a pre-privatization plan.” So I am not going to cover that ground here except to quote the key relevant passage in that post:

To my mind, there are three ways to deal with an insolvent financial institution:

Bankruptcy. Allow the institution to collapse (like Lehman Brothers (LEHMQ.PK))

Nationalization. Seize the assets of that institution and nationalize it (like Northern Rock, AIG, or Fannie Mae)

Bailout. Inject capital into the institution in order to allow it breathing room until it can meet capital adequacy levels.

As you can see, governments have tried all three solutions. However, there are vast differences between the three.

The bailout solution is the most ‘anti-free market’ choice and seems to be the favored solution of governments everywhere. It props up organizations, giving them an unfair advantage at the expense of other more prudent institutions. It also acts as a subsidy, which favors domestic institutions over foreign rivals. Bailouts increase moral hazard by rewarding risky and reckless lending practices. And they are often the result of crony capitalism due to the power of the financial services lobby. There are many other problems with bailouts. All around, bailouts are a poor solution.

So what we have here is a case of crony capitalism and kleptocracy, plain and simple – whether by design or not is immaterial. And the American people are on to this. That is why people are resistant to other changes this Administration has put forth.

Don’t let the media’s spin fool you: Washington insiders are on to this too. Politicians in Congress realize that Obama’s bailouts have cost him political capital and they are challenging his policy agenda as a result. This is why the health care bill, which Obama wanted passed before the summer recess, may not see the light of day before year’s end.

Are we home safe?

I would advise the Obama Administration not to run any victory laps about having slayed the beast. The lingering effects of crisis are still there. The Fed’s liquidity is still liquid. Impaired assets are still impaired. And zombie banks are still zombies. As I indicated in my depression piece:

In reality, the problems of high debt levels in the private sector and an undercapitalized financial system are still lurking, waiting for the government to withdraw its economic support to become realized.

Since I covered this ground in that article, I will leave you to read my further thoughts there. What I want to turn to now is the ‘why.’

The Cheney-Rumsfeld replay

Now, I am not writing off Barack Obama’s presidency. I do worry he still could see a recessionary relapse which would cause him to seem more Herbert Hoover than Franklin Roosevelt. But, despite his Nobel Prize, it is much too early to know what his legacy will be.

Nonetheless, I believe he has wasted a lot of political capital and this will make ushering through a meaningful legislative agenda very difficult.

Why did Obama throw it all away?

Here’s my answer: I call it the Cheney-Rumsfeld replay.

When historians look back at the Bush 42 presidency, it will be defined by 9/11 and the wars in Iraq and Afghanistan. While George W. Bush was politically pre-disposed to the Neo-con world view, it was really advice from Dick Cheney and Don Rumsfeld which made Afghanistan and Iraq possible. George W. Bush was famously not well-versed in foreign affairs, having almost never travelled abroad. He was completely dependent on Dick Cheney and Donald Rumsfeld to make foreign policy (although he could have listened more to Colin Powell, his actual Secretary of State; again it goes to predisposition).

So, I see George W. Bush’s presidency as having been defined by foreign policy and the War on Terror and, by extension, on Rumsfeld and Cheney.

Fast-forward to Barack Obama’s presidency and you have an almost identical situation, this time with the economy instead of foreign policy and Tim Geithner and Larry Summers instead of Donald Rumsfeld and Dick Cheney.

But, as with George W. Bush, it goes to pre-disposition. Paul Volcker was a critical member of the Obama 2008 campaign. He also was a key member of Obama’s economic policy team. But, he has been speaking a very discordant message that is not in sync with team Obama. So, as with Bush and his marginalization of Powell, one has to believe Barack Obama has chosen to side with Geithner and Summers over Volcker. Why anyone would do so given Volcker’s experience is beyond my comprehension.

The obvious conclusion, therefore, is that Barack Obama shares the blinkered and captured view of his policy makers and that this is why he has decided to go down this chosen path. And when it comes to Obama’s other ‘change’ decisions on the Guantanamo closure, torture, rendition, state secrets, and health care, the same logic also applies.

Is this change we can believe in? I will leave that for you to decide.

Comments

[epeon:]

I must admit that I am very disappointed by Obama. Since the US government owns several banks what I don't understand is why the administration doesn't break these up into smaller pieces. Pieces that are not "too big to fail." What Obama is doing is just giving tax money away. Very disappointing.

Nov 08 03:13 AM

[joetama:]

Sorry, Mr. E. H. you are totally wrong, I believe because you are not in charge of the entire situation (no. 1) another part is economist now drastis changes where not one know the new's rule's, by the way personals interest affecting others and banker's invest in their own business not how they so post to do that is now the pay back.. the other hand reality is quite different to the books.

att, J. Tama

Nov 08 05:39 AM

[Rokjok777:]

I was a hardened Dem from California so I was in favor of Obama over McCain/Palin. But Obama's inexperience is showing. He trusts "experts": how to fix Wall St? Ask Summers & Geithner! What to do about Afghanistan? Ask the generals! Well, of course they're gonna say "yeah just give us thousands of more troops and plenty of more bombs and billions of dollars, it'll all be great!"
As I say, I used to be a hardened Dem from California, now I'm a sunburned Aussie from Sydney...

Nov 08 05:48 AM

[the gerald:]

if as you more or less imply, fnm/fre have been nationalized, does that not violate the fifth amendment of the constitution? must not the owners (shareholders) be compensated?

if one examines the recent quarterly filings of each, they are not as valueless as the wall street journal portrays them to be.

Nov 08 09:19 AM

[Ferdinand E...:]

So the American people are on to Obama, says this author. They see and understand the so-called weakness in his economics.

Well, they weren't on to George W. Bush when he told the lies that led to the problem in Iraq, and those lies were right out there in the open where they could be seen and examined in detail.

As for siding with Summers over Volckner, that's easy. Where economics is concerned, Summers is a genius, and Mr V. is an also ran.

Nov 08 09:32 AM

[the Gnome:]

I am afraid you are absolutely right, but Obama hasn't 'fallen' into the hands of social re-engineering subordinates--he is the principal cheerleader! No matter the costs, he is out to change America to a more socialized, increased government control model.

Notice how very little appears about the sky rocketing Fannie and Freddie losses now that they are government owned. AIG and the auto company bail outs are being dwarfed by comparison.

What we readers have to do, selfishly, is figure how to make money out of these disasters to protect our own families.

Nov 08 10:14 AM

[CLH:]

I certainly agree with your take on Obama. Foreign affairs is the main thing that the Federal govt. should be concerned about (as was Bush). The Federal govt. should stay out of economics and leave it to the private market. Obama's main problem is that he is a Democrat. A party that believes that the govt. should run the economy.

This is called socialism and does not work.

Nov 08 01:25 PM

[tommiegun:]

Its time for the gov't to start getting out of Citi and BOA. They are both carrying large cash balances in the hopes that they can begin to pay back the gov't.

The gov't loans are disruptive to their businesses as they cannot invest properly second guessing when the gov't will allow a repayment.

Geithner needs to make his intentions known.

Nov 08 05:47 PM

[derryl:]

Obama is certainly not the first President who got elected and then discovered that "the world is ruled by very different personages than it would appear" (I think I'm misquoting what FDR said upon leaving office, though I may have the wrong President, but that's the gist of the message).

I think Obama really believed that the Presidency would give him the power to implement the kinds of changes that he thought would improve America. Then he discovered that banksters own the economy and various sub-system interest groups rule their own fiefdoms within the country; the medical-industrial complex for e.g., and the trial lawyers.

I think most of us on SA have to admit that we have learned a lot about how the financial system is run, things we didn't know before, over the past year. And there is no reason to think Obama understood the system and its rulers when he took office. Only a few Wall St insiders know what has been going on over the past decade or more and it is only recently that investigative journalists and bloggers like Matt Taibbi and Edward Harrison have been making that information widely known.

To make the changes he wanted Obama would have to pry all the entrenched interests out of their fiefdoms and subject them to the kinds of regulations that serve America as a nation rather than merely serve the interests of the fief-lords and their vassals. But how can a President hope to win battles against trillionaire banksters who understand their system, when Obama has no money and no understanding? Likewise with other captured industries. The entrenched interests have all the weapons and all the power.

It's not too late for Obama. He's still in his first year in office. But if he's to succeed he'll have to transform himself from a naive idealist into a hardass realist. He'll have to be a trustbuster, an enemy of oligopolists and entrenched interests, a restorer of free markets. Obama still seems to think central planning can solve a lot of America's problems. So I'm not sure he's the right guy to break up the central planners in America's captured financial, health care, military and other industries. But I wouldn't be shocked if Obama did a mid-term about face in his thinking, after realizing the true state of the nation that he genuinely wants to heal.

Nov 08 06:58 PM

[tommiegun:]

Obama vs. the Repubialinas

The Repubs. have formed a tight circle hoping to recapture the whitehouse soon.

F....the people and what they need. We're gonna F....vote no on everything sink this B....ch.

If we make it out alive they'll see that we were right.

Nov 08 08:13 PM

[ryanclarke:]

I truly believe after nearly a year of the Fed ZIRP policy the answer should be obvious as to why Obama didn't "listen" to Volcker. The debts levels in this county have increased to such a degree from the debt levels in 79-81 ... and not just Fed debt but business debt as well ... that raising short term interest rates on the existing debt would pressure the U.S. ( and big U.S. business ) into default. Japan is stuck at 0% for the same reason ... if Japan was to do something about their weak currency ... Japan would in turn default on it's issued debt. Volcker, if my recall of history is correct, didn't get aggressive on inflation until after the Iraq-Iran War was under way ... and the lack of stability in the Middle East prevented foreign money from flowing to the region ... instead money flowed to the U.S. in the early 80s. My hunch is, in geopolitical terms, the U.S. is "waiting" for a similar event somewhere in the world to occur before it does something about the weak dollar.

Nov 08 10:06 PM

[Obamitall:]

Another good thought-provoking article.
Obama clearly reflects all the ideals of those with whom he chooses to associate. The only change we'll get from this administration is European socialism and mediocre standards for all.

Nov 09 07:02 AM

[Warm_Paw:]

I for one am not blaming Obama for this mess. It began in 1999 2000.
The problem is, Obama's been handed the problem and is listening to the people who created this problem and are lining their pockets on his presidency. Half of the bailout money was handed out pre Obama leaving Obama holding the bag in handing out the other half.
There's no way one wins a presidential election and can be up to speed with the finances of the country.
Bush handed Obama a time bomb.
The problem I have is that Obama continues down the path of his own destruction by not getting his own people, or even expert advice on what is occurring. He's relying on the crooks who did this to inform him. A fox watching the henhouse.
Even yet the people who are responsible for this systemic risk, fight regulation. Guess why that is?
Obama should let whatever institution that took the risk, fail.
Strong institutions are there to pickup business from the risk takers.
No one knows what the result would have been had these institutions had not been bailed out.
They've been bailed out and the average citizen is not enjoying any signifigant change because of that. Just the banks are enjoying survival at the expense of the tax payer.
A naive president believes everything everyone tells him when it offends the senses.
The emporer is wearing no clothes.

Nov 09 11:20 AM