Now that we have a rough idea how President Barack Obama and his lieutenants plan to prop up insolvent financial institutions using taxpayers’ money, we’re left with a more difficult question: why bother? Why doesn’t the Obama administration force insolvent banks and insurance companies to come clean about their losses first? More than anyone else’s, it should be in Obama’s self-interest to accelerate the worst of the financial crisis and get as much of the inevitable pain behind us as quickly as possible. Every day he waits is one less day he will have between the time we hit rock bottom and the next election. And yet Obama and his minions are doing all they can to delay the reckoning, which will only make it worse.
When publicly owned companies change management, often the smartest thing a new chief can do is clear the decks and take a ‘big bath’ charge to earnings. In other words, the company writes off all its worthless assets and reports huge losses, pushing every conceivable drop of red ink into the past. The new CEO gets to blame his predecessor’s dumb mistakes. The firm gets a fresh start with the investing public. Obama could have taken the same approach with the banks the moment he took office. While he still had standing he could have blamed the financial crisis on George W. Bush’s administration, stupid regulators, and corrupt law-makers – that is, everyone but himself.
The new president could have ordered all US financial institutions to immediately confess whatever losses they hadn’t yet recognised. And he could have backed that up by vowing to prosecute every officer, director and auditor the Justice Department could find who had approved numbers they knew to be wrong. He didn’t do that. And now, six months into the government’s Troubled Asset Relief Program, his administration’s approach to the financial crisis is largely indistinguishable from its predecessor’s. The only objective, it seems, is to buy time in the hope that an economic recovery will materialise and lift the financial system back to health. The Obama administration’s ‘strategy’, for lack of a better word, is to keep plying broken financial institutions with as much taxpayer money as the government can print. And so the government will keep subsidising failed mega-banks indefinitely, rather than placing any into receivership or liquidating them.
The latest iteration of this policy is the Treasury Department’s Public-Private Investment Program. In short, struggling financial institutions will be encouraged to swap their most toxic mortgage-related assets with one another at inflated prices. The purchases will be financed by big government loans, so that taxpayers are at risk for the bulk of any losses.
If the government wanted transparency, it would force financial institutions to write-down their bad assets now, and figure out afterwards which companies deserve taxpayer support. Instead, the Treasury plans to recapitalise them first, keep their current financial condition hidden, and let their failed managers stay in their jobs. The key assumption underlying this plan is that the declines in the values of these companies’ toxic assets are the result of private investors’ temporary reluctance to buy them, and that prices will rebound if the Treasury can revive the markets where these assets trade. However, the Treasury hasn’t explained why it believes the assets’ proper values are their original book values, rather than the prices unsubsidised investors are willing to pay for them. (This is one of the points made in a 7 April report by the US bail-out program’s Congressional Oversight Panel.) If the Treasury’s hunch proves wrong, the government will need to rely on something other than a rising economy to restore the banks to solvency.
So why doesn’t the Obama administration force the banks to write-down their troubled assets first, as a condition of government assistance? We can only speculate because the government’s own explanations so far have made no sense. Perhaps it is scared the markets would panic if large, insolvent financial institutions started telling investors just how undercapitalised they are. Or there’s the distinct chance some of Obama’s advisers are beholden to failed banksters, because they used to work for them and may want to do so again someday. There could also be a manpower problem. The government might not have enough employees to seize all those sickly banks and supervise the process of winding them down.
Most likely, it’s some combination of those and other factors. Because why else would the Treasury tell the 19 biggest US banks to undergo ‘stress tests’ of their financial health, and then put the banks in charge of performing the tests? And this might also help explain why regulators pressured the board that sets US accounting standards to weaken the rules on mark-to-market accounting, so the banks could hide their losses and show more capital. Whatever the cause, as long as the government refuses to remove the zombie banks from our financial system, there’s little hope the US will return to robust economic growth. And the longer these zombies are allowed to stagger along with no reckoning in sight, the greater the risk for Obama that voters will conclude he’s as responsible for blowing the clean-up as others were for causing the crisis. He’d better act soon.
• This article was first published on Bloomberg.com.