synthetic zero

April 14th, 2009

Like a lot of you, I’ve been discussing the economy with quite a few people, and I wanted to blog my thoughts on it here.

First of all, I tend to think that the efforts the Administration has put into place so far to deal with the financial crisis may well be insufficient, as many have argued. However I do not believe their approach is a mistake, at least as a first step, for a number of reasons.

Quite a few people have argued that we ought to force many of the big banks into FDIC receivership or some other form of nationalization as soon as possible, in order to clean them up and sell them back to private investors, so they can begin lending again. The argument that Geithner has been making is that they don’t want to do this except as a last resort, because the resulting panic might well destabilize the global economy at just the wrong moment. There’s a lot of anger out there at the banks, and at bankers, most of it quite justifiable. Many people are incensed at the idea that bankers are getting bailouts while the rest of us out here are dealing with an economic debacle.

First of all, it seems to me that Geithner is a bit too close to Wall Street and has made some politically unwise recommendations. However, I do believe that he, and Obama, are motivated by trying to stabilize the economy. I think they really believe that premature bank nationalization of the largest institutions could lead to a panic that would make the Lehman Brothers panic look like a walk in the park by comparison; and furthermore I think they have good reason to think this.

But more importantly I think we’ve been looking at the wrong targets here. The problems we’re facing are not simply the result of a small number of selfish bankers. They’re due to a larger, systemic problem. Yes, executive pay in nearly every industry, particularly in financial services, is totally out of control; it’s obscene. But the reason for our current predicament is not that a bunch of evil bankers tried to fleece us all — it’s because a bunch of relatively selfish, greedy bankers tried to maximize their returns in a short-sighted way, playing by the rules as they’ve evolved over the last few decades of excessive deregulation.

The idea that bad things happen just because some bad people screwed things up is rather naive, in my view. If we focus on that, we might get rid of one batch of bad guys but just have another gang come in to take their place. It’s a kind of Hollywood notion, that there are good guys and bad guys, and bad things happen just because of the bad guys. I think that’s just not reality.

Sure, the worst management teams ought to be replaced; the worst boards should be replaced. But if you’re relying on some “better” bankers coming in and saving us, that’s going to be a long wait.

We need to focus not so much on who’s playing the game but on the rules of the game itself. We need to roll back a lot of the imprudent deregulation since Reagan and we need to come up with new, better regulations for the future. The changes we need to make had better work whether or not we have good guys or bad guys in charge of the banks. Relying on good guys to do the right thing is clearly not workable. Sure, I agree that many bankers were selfish, irresponsible, greedy, and on and on … but that was inevitable, given the rush to deregulation we’ve seen. The system is what made it possible for these guys to operate in the way they have. Just punishing the evildoers here won’t do nearly as much as changing the game.

Why not nationalize right now, fire the boards, etc.? Well, I think Geithner is right to go slow with that. First find out with some confidence which banks are insolvent. If we have to nationalize some of them or force them into receivership, we ought to know which ones really need that and which do not, so we can avoid sowing panic in the markets. If the government forces Citigroup into receivership but there’s uncertainty about which bank is next, a panic could well ensue, forcing all of us to pay a heavy price. Instead, let’s start to try to get some pricing on these CDOs via Geithner’s public-private partnership and then see where we are. The key thing is whatever intervention is necessary ought to happen when we have some clarity about the financial condition of these institutions, so panic can be averted. I’m all for punishing the bad guys but I’d rather not do it by burning the city down at the same time. Let’s put out the fire first THEN figure out how to rebuild so we’re not as vulnerable next time.

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