I understand why the Administration had been working overtime to try to prop up major banks–but understanding does not mean agreement with the long-term strategy. In fact, the question worth asking today is not whether the stress tests are accurate or whether more taxpayer money will be needed to shore up the major banks. It is actually this: why are we not using this crisis to create a new banking system?
In today’s New York Times, Treasury Secretary Timothy Geithner argues in an op-ed that the stress tests have given the financial system a road map forward and reassurance that will free up credit markets:
We brought together bank supervisors to undertake an exceptional assessment of the strength of our nation’s 19 largest banks. The object was to estimate potential future losses, and ensure that banks had enough capital to keep lending even in the face of a deeper recession.
And…
The test results will indicate that some banks need to raise additional capital to provide a stronger foundation of resources over and above their current capital ratios. These banks have a range of options to raise capital over six months, including new common equity offerings and the conversion of other forms of capital into common equity. As part of this process, banks will continue to restructure, selling non-core businesses to raise capital. Indeed, we have already seen banks, spurred on by the stress test, take significant steps in the first quarter to raise capital, sell assets and strengthen their capital positions. Over time, our financial system should emerge stronger and less prone to excess.
In an indirect rebuttal today to Geithner in The Financial Times, Nourel Roubini, who as many people know, famously predicted the financial crisis before it broke out, co-authored a piece that basically says let the insolvent banks fail and learn how to manage those failures:
Once again, the question will be how the near-insolvent banks can be kept afloat, to avoid systemic risk. But the question we really should be asking is: why keep insolvent banks afloat? We believe there is no convincing answer; we should instead find ways to manage the systemic risk of bank failures.
And…
This discipline would force the remaining banks to change their behaviour, probably leading to their breaking themselves up. The reform of systemic risk in the financial system would be mostly organic, not requiring the heavy hand of government.
Why did creditors not prevent the banks taking excessive risks before the crisis hit? For the very same reason creditors are getting a free pass now: they expected to be bailed out. For capitalism to move forward, it is time for a little orderly creative destruction.
Okay, so, here’s what I would say. Geithner’s position is understandable given his background–and I don’t mean that in the sometimes conspiratorial language that some observers have framed it. Quite simply, he is a product of the big bank mentality. That is, the Citibank model.
Roubini, at least, in this piece, refers to banks "breaking themselves up" but it’s not clear that he means that a recombination of pieces down the road is a bad outcome. And, while it’s fine to suggest throwing the bondholders to the wolves, he doesn’t seem to recognize that letting a big bank fail means that thousands of workers would lose their jobs.
As I see it, the reason to let big banks fail (but in such failure workers must be protected by long-term income replacement as part of a government-managed failure) is to try to manage the recreation of a new banking system where we return to regional and community banks, rather than a national banking system dominated by multi-national banks–a system that was a significant factor in the financial crisis we are living through.
I mean by that banks that care somewhat more about lending money to the mom-and-pop small business down the street, rather than trying to figure out how to do business with a derivatives trader half way around the globe.
Let’s not be naive: financial mismanagement, corruption and speculation can happen at the non-Citibank institutions as well (remember the savings and loan debacle?). But, if we truly want to rethink the purpose of our financial system, we will not do so by saving the current model. And one element of that, I would argue, is to encourage a new culture where bankers are pushed to remember that liquidity and credit in a community are not abstract tools. Rather they are supposed to be mechanisms to advance prosperity for the people, not simply to fatten a bottom line.
