Begging the Banks

Treasury Secretary Henry Paulson today called on the banks that the federal government has just given $250 billion dollars to make that money available to others in the economy.

“We must restore confidence in our financial system,” Paulson said. “The needs of our economy require that our financial institutions not take this new capital to hoard it, but to deploy it.”

The “needs of our economy” might require that the banks not hoard the money that the government has given them, but the Bush administration isn’t requiring much of anything.

I agree with Paulson that the economy will not begin to recover until there is liquidity in the credit markets.  That, indeed, was the rationale behind the government’s massive and unprecedented bailout of the financial industry.

Why, then, is Paulson asking the banks to do the only thing that justified giving them those billions of taxpayer dollars?

If, as is apparent to just about everyone, the economy will not recover until liquidity is restored to financial markets, why doesn’t the federal government require that the banks not hoard the billions that the government is giving them?

The answer is that, despite the acuteness of the financial crisis, and despite the government’s belated decision to take large scale action, the basic approach of the Bush administration has not changed.

In fact, for the past year, the Bush administration has taken a consistent, and faulty, two pronged approach to dealing with the expanding economic crisis, and this approach has not changed with the latest bailout.

This two pronged approach is

• (1) make capital available at extremely low rates to banks and financial institutions with the goal of restoring liquidity, and then
• (2) beg and plead with these same banks and financial institutions to move this capital into the economy.

As the housing and mortgage crisis worsened, Federal Reserve Chairman Ben Bernanke announced a series of cuts in interest rates.  Each time, Bernanke repeated his call for lenders to voluntarily reduce the principal on delinquent loans to adjust them for the drop in home prices, rejecting the far more more forceful action proposed by Democrats favoring legislation that would require the refinancing of hundreds of thousands of mortgages.

Of course, the banks did not voluntarily do what Bernanke requested.

Now Treasury Secretary Paulson is following the same dead end path in asking the banks to voluntarily take the actions that are needed for the restoration of the market.

The Bush adminstration’s beg and plead approach did not work in the past, and it will not work now.

Of course, no one, except the apocalypticals of the far Left and Right, and Libertarians driven crazy by ideology or alcoholism, want to see the global economy collapse.  Sane people don’t want to see bread lines or live with their guns at the ready in a bunker in the woods.

But we can now longer expect that capitalists, driven by personal gain, will voluntarily act to save the system that sustains them.

What is needed is a comprehensive and mandatory overhaul of the entire banking and financial system and the credit markets on the order of the Securities and Exchange Act of 1934.

And for that, we’ll have to wait at least until a new Congress, a new administration, and a new political and economic philosophy take over in January 2009.

I hope we last that long.

Disaster Capitalists Staking Out U.S. Banks

Disaster capitalists are staking out the U.S. banking industry. 

Private equity firms have long wanted to move into banking.  And given the financial crisis that many banks are now facing, isn’t this a good time to allow private equity firms, with their billions of dollars of available resources, to come riding to the rescue?

According to an editorial in the New York Times, “for the past month, some private equity firms have been promoting what they claim would be a relatively pain-free fix of the nation’s banks . . . Private equity firms say they are ready to invest huge amounts in ailing banks — provided the Fed eases up on the regulations that would otherwise apply to such large investments. The firms’ desire to jump in makes perfect sense. Bank shares are cheap now, but for the most part, are likely to rebound when the economy improves.”

What the private equity firms want in return for playing the role of savior are significant changes in banking regulations.  

“Under current rules,” the Times explains, “if an investment firm owns 25 percent or more of a bank, it is considered, properly, a bank holding company, subject to the same federal requirements and responsibilities as a fully regulated bank. If a firm owns between 10 percent and 25 percent of a bank, it is typically barred from controlling the bank’s management. To place a director on a bank’s board, an investor’s ownership stake must be less than 10 percent. The rules exist to prevent conflicts of interest and concentration of economic power. They protect consumers and businesses who rely on well-regulated banks, as well as taxpayers, who stand behind the government’s various subsidies and guarantees to banks.  To maximize their profits, private equity firms want to own more than 9.9 percent of the banks they have their eye on and they want more managerial control — and they want it all without regulation. They argue that because they tend to be shorter-term investors, problems that the rules address are unlikely to occur on their watch.”

The private equity firms’ grab for the gold is an example of what Canadian writer Naomi Klein calls the “shock doctrine” of “disaster capitalism.”

The basic idea of the shock doctrine is that corporations are able to remove regulations and operate without governmental oversight when citizens are in a state of shock from a traumatic event, such as a natural disaster, a war, a coup, or an economic crisis and are desperate for a solution and unable to mobilize effective opposition.  When these crises occur, corporations exploit them by promising a solution — the catch is that in return for their solution, the corporations demand the drastic reduction or elimination of regulation and public oversight.

In her book The Shock Doctrine: The Rise of Disaster Capitalism, Naomi Klein identifies University of Chicago economist and Nobel Prize winner Milton Friedman as the ideological father of the Shock Doctrine: “In one of his most influential essays, Friedman articulated contemporary capitalism’s core tactical nostrum, what I have come to understand as ‘the shock doctrine’. He observed that ‘only a crisis – actual or perceived – produces real change’.  When that crisis occurs, the actions taken depend on the ideas that are lying around. Some people stockpile canned goods and water in preparation for major disasters; Friedmanites stockpile free-market ideas. And once a crisis has struck, the University of Chicago professor was convinced that it was crucial to act swiftly, to impose rapid and irreversible change before the crisis-racked society slipped back into the ‘tyranny of the status quo’. A variation on Machiavelli’s advice that ‘injuries’ should be inflicted ‘all at once’, this is one of Friedman’s most lasting legacies.”

Examples of the application of the shock doctrine offered by Klein are the government-corporate responses to Hurricane Katrina, the 9/11 attack, the war in Iraq, the oil crisis, and the global food crisis.  In each instance, Klein argues, corporations systematically exploited, and are still exploiting, the state of fear and disorientation that accompanied the shock and crisis to remove regulations and government oversight of their activities.

That’s exactly what’s behind the private equity firms’ solution to the banking crisis.  As the Times points out, “the private equity firms are exploiting the desperation of banks and regulators. They know that banks are desperate to raise capital and that doing so is a painful process bankers would rather avoid. They also know that regulators and other government officials, many of whom where asleep on the job as the financial crisis developed, want to avoid the political fallout and economic pain of bank weakness and failure.”

Giving in to the private equity firms’ offer to save the banks in return for fundamental regulatory concessions would be a serious mistake. 

As the Times explains, “Now, when there is great uncertainty about which institutions are too big or too interconnected to fail, is exactly the wrong time to allow less transparency and less regulation. And with confidence in the financial system badly shaken, it would be a mistake to signal to global markets and American citizens that the government is willing to put expediency above long-term stability.”

In fact, the responsible response to the current crisis is not less regulation, but more effective and focused oversight.  As economist Austan Goolsbee (also of the University of Chicago) said in a Dow Jones interview, “If you can borrow money from the U.S. taxpayer at a moment of crisis, that is a very sacred insurance policy underwritten by the U.S. taxpayer.  We have the right to oversee anyone who is accessing that insurance policy.”

It remains to be seen whether Congress will capitulate to the private equity firms’ demands. 

Most likely, this will be one of the issues that are decided by the November elections.