The United States treasury’s plan to deal with “toxic assets” relies on the very financial institutions that created the economic whirlwind. The young presidency is already in a vice, says Godfrey Hodgson.
President Barack Obama joked in his press conference on 24 March 2009 that the euphoria of his inauguration two months earlier had lasted only a single day. The hope he had the audacity to proclaim is not yet dead. But – even as he prepares to leave for a trip to Europe that will encompass the G20 summit in London (2 April), the Nato anniversary summit jointly hosted by France and Germany (3-4 April), and visits to the Czech Republic (4-5 April) and Turkey (6-7 April) – the future prospects of his presidency are already in the balance.
Among openDemocracy’s articles on the economic crisis:
Willem Buiter, “The end of American capitalism (as we knew it)” (17 September 2008)
Ann Pettifor, “The week that changed everything” (22 September 2008)
Will Hutton, “Wanted: a fairer capitalism” (6 October 2008)
Avinash Persaud, “Europe’s financial crisis: the integration lesson” (7 October 2008)
Paul Rogers, “A world in flux: crisis to agency” (16 October 2008)
Andre Wilkens, “The global financial crisis: opportunities for change” (10 November 2008)
Simon Maxwell & Dirk Messner, “A new global order: Bretton Woods II…and San Francisco II” (11 November 2008)
Larry Elliott, “From G8 to G20: the end of exclusion” (16 November 2008)
Krzysztof Rybinski, “A new world order” (4 December 2008)
Paul Rogers, “A world in revolt” (12 February 2009)
Katinka Barysch, “The real G20 agenda: from technics to politics” (16 March 2009)
Krzysztof Rybinski, “There is no zombie free lunch” (18 March 2009)
Sue Branford, “The G20′s missing voice” (26 March 2009)
Will Hutton, “A G20 deal: power bends to protest” (29 March 2009)
With great courage, Obama has insisted that he would stick to his promises to tackle long-term failings in American society, even as he struggled to heal the economic crisis. He continues to press for these reforms – in climate-change policy, healthcare, public education, dependence on imported oil, and growing inequality – even as he grapples with the blocking of credit and the terrible unemployment that is one of its consequences.
The week of 23-29 March saw a new twist: the emergence of a deadly dilemma that the president has to resolve. He has learned that he cannot unblock credit without going a long way to appease the interests of the bankers who caused the problem in the first place. At the same time he has become aware of the rising fury among everyday Americans triggered by the huge bonuses paid to executives at AIG, the giant insurance company that in 2008 posted the biggest losses in American business history.
Everyone agrees that the knot that has to be cut is the astronomical quantity of “toxic assets” poisoning the balance sheets of American banks – as well as those European banks (the Royal Bank of Scotland, Paribas, Deutsche Bank and UBS among them), which thought it was clever to copycat every Wall Street fashion.
The plan unveiled by Obama’s treasury secretary Timothy Geithner on 23 March hands to the banks the juiciest of “sweetheart” deals to persuade them to buy up what Geithner calls “legacy assets” (the financial crisis has given free rein to American public life’s culture of euphemism).
The president’s vice
Geithner’s plan distinguishes between securities based on truly valueless loans and those whose value has simply been depressed by the economic downturn. It proposes that the treasury and “private investors” – which in practice can only mean the investment banks, commercial banks and hedge-funds which created and invested in the toxic assets in the first place – will buy equal amounts of the unsaleable assets. But private investors will only be able to do so thanks to a far larger injection of money to be lent by a government agency, the Federal Deposit Insurance Corporation (FDIC).
Altogether it is calculated that private investors will contribute 6% or 7% of the money to clean up the banks’ balance-sheets. The taxpayer, in the shape of the treasury and FDIC, will put up more than 90%. That, in the good old days before Wall Street collapsed, used to be called “leverage” of perhaps thirteen-to-one. With government standing behind them to that extent, why wouldn’t the banks buy trash at prices kited with government money?
Timothy Geithner makes much of the importance of keeping the rescue in the private sector, which it patently is not. He also speaks warmly of the professional skills that will be devoted to the task by the very speculators who brought the economy to its knees.
The liberal economic intelligentsia don’t like it. Jeffrey Sachs calls it a “massive transfer of wealth from taxpayers to bank shareholders”. In a deadly back-of-the-envelope calculation he estimates that the plan will hand $276 billion – even today a not inconsiderable sum – directly from the taxpayers to bank shareholders (see Jeffrey Sachs, “Will Geithner and Summers Succeed in Raiding the FDIC and Fed?“, VoxEU, 25 March 2009).
The Nobel laureate and New York Times columnist Paul Krugman dismisses the plan as not much more than a revival of the George W Bush administration’s plan to absorb the banks’ toxic assets: just more “cash for trash”. The economist and former labour secretary, Robert Reich, and the Columbia University scholar Joseph Stiglitz are equally acerbic (see Edward Luce, “America’s liberals lay into Obama“, Financial Times, 27 March 2009).
The co-editor of The American Prospect and respected commentator, Robert Kuttner, says the Obama administration has chosen “the most expensive and risky way of trying to recapitalise the banks, and the least likely to succeed”. Kuttner also identifies a point that is likely to be the target of much angry criticism, namely that the president has turned to “the same Wall Street crew” who failed to handle the situation under the Bush administration, and indeed who were largely responsible for what went wrong in the first place: Robert Rubin, Laurence Summers, and their protégés (see Robert Kuttner, “Geithner’s last stand“, Huffington Post, 22 March 2009).
If anyone had any doubts about who would benefit from the Geithner “public-private partnership”, they had only to watch how the stock market responded. Bank shares overall rose by 10% in the aftermath, but the biggest banks that have survived did better than that. Citigroup was up 19%; Bank of America shot up 26% in heavy trading; Wells Fargo’s shares rose by 24%, and J.P. Morgan Chase‘s by 25%. A day later, however, the wave of market enthusiasm had subsided.
The truth is that Obama now finds himself in a new vice. He feels he needs people from Wall Street to solve the street’s problems. That is one reason why it has taken him so long to fill the key jobs at the treasury under Geithner. At the same time he clearly underestimated the rage Main Street citizens feel both at the AIG bonuses and the broader proposition: that while they face losing their jobs and their homes because of the folly and greed of the financial sector, the only people who walk away laughing are the folks who caused the disaster in the first place.
No wonder that questions are being asked about the ubiquitous presence of present and former executives of Goldman Sachs in the Obama administration, just as in the ranks of its precedessor.
A time to choose
Barack Obama showed in his long campaign for the presidency that he is a very skilled politician. He is also by temperament cautious, even conservative. His instinct is to “reach across the aisle” in order to cure what he sees as the excessive partisanship of the years since the “Reagan revolution“. He is too a patient man. But now he understands that he has got to move fast if he is to save the hopes of his presidency (see “Barack Obama: don’t waste the crisis“, 6 February 2009).
In this the president is both beneficiary and victim of larger historic forces. The same event that cleared his way to the White House, the financial crisis symbolised by the fall of Lehman Brothers on 15 September 15 2008, may have made it impossible to govern; or at the least, may mean that he will have to sacrifice at least some of his hopes of long-term reform (see “The week that democracy won“, 29 September 2008).
In the short term, in order to heal the financial crisis it looks as though he has had to put the fate of his administration in the hands of the men from Wall Street.
Amid the stock-market panic of 1907, the financier JP Morgan was surprised that President Theodore Roosevelt didn’t “send your man to fix things up with my man”. It couldn’t be done like that then, and it can’t be done now. But the young president and his even younger treasury secretary have nonetheless been taught a hard lesson in political economy.
To govern is to choose, as Aneurin Bevan – the Welsh architect of Britain’s post-1945 national healthcare system – said. It is now clear that inviting the poachers to act as gamekeepers was a mistake. Many Americans long accepted the conservative contention that government was the problem, not the solution. That phase of history seems to have ended, and a progressive president finds himself coping with a new wave of populism of a kind that seemed to have disappeared from America politics for generations. He means to govern, and he will have to choose.
Godfrey Hodgson was director of the Reuters’ Foundation Programme at Oxford University, and before that the Observer’s correspondent in the United States and foreign editor of the Independent. His books include The World Turned Right Side Up: a history of the conservative ascendancy in America (Houghton Mifflin, 1996); More Equal Than Others: America from Nixon to the New Century (Princeton University Press, 2006), and A Great and Godly Adventure: The Pilgrims and the Myth of the First Thanksgiving (PublicAffairs, 2007)
At Open Democracy: http://www.opendemocracy.net/article/barack-obama-end-of-the-beginning
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This Is Your Economy on Credit Crack – and Heading for a Crack-Up
Here is a clear and simple explanation of why we may have already passed the point at which the Fed and Treasury will have no choice but to substantially devalue the bonds and reissue a ‘new US dollar’ as part of a managed default on our sovereign debt.
Ben’s Un-shrinkable Balance Sheet
Delta Global Advisors
April 14, 2009
As he stated again clearly today, the Chairman of the Federal Reserve has deluded himself into thinking that when the time comes, he will be able to shrink the size of the Fed’s balance sheet and reduce the monetary base with both ease and impunity. He also has deluded himself into thinking inflation will be easily contained.
It is very important that he does not fool you as well.
The Fed believes low interest rates should not be the result of a high savings rate, but instead can exist by decree, a conviction which has directly led consumers to believe their spending can outstrip disposable income.
The result of such thinking has been a rise in household debt from 47% of GDP in 1980 to 97% of total output in Q4 2008. As a result of this ever increasing burden, the Fed has been forced into a series of lower lows and lower highs on its benchmark lending rate. Keeping rates low is an attempt to make debt service levels manageable and keep the consumer afloat. Problem is, this endless pursuit of unnaturally low rates has so altered the Fed’s balance sheet that Mr. Bernanke will be hard-pressed to substantially raise rates to combat inflation once consumer and wholesale prices begin to significantly increase.
Banana Ben Bernanke has grown the monetary base from just $842 billion in August 2008 to a record high of $1,723 billion as of April 2009. But it’s not only the size of the balance sheet that is so daunting; it’s the makeup that’s becoming truly scary.
Historically speaking, the composition of the Fed’s balance sheet has been mostly Treasuries. And the Federal Open Market Committee would typically raise rates by selling Treasuries from its balance sheet into the market to soak up excess liquidity. However, because of the Fed’s decision to purchase up to $1 trillion in Mortgage Backed Securities (and other unorthodox holdings), it will not be selling highly-liquid US debt to drain reserves from banks. Rather, it will be unwinding highly distressed MBS and packaged loans to AIG. Not to mention the fact the Fed would have to break its promise of being a “hold-to-maturity investor” of such assets.
Moreover, not only are the new assets on the Fed’s balance sheet less liquid but the durations of the loans are being extended. According to Bloomberg, the Fed is contemplating extending TALF loans to buy mortgaged backed securities to five years from three after pressure it received from lobbyists and a failed second monthly round of auctions. That means when it finally decides it’s time to fight inflation, the Fed will find it much more difficult to reverse course.
But because of the extraordinary and unprecedented (some would say illegal) measures Mr. Bernanke has implemented, only $505 billion of the $2 trillion balance sheet is composed of U.S. Treasury debt. Today, most Fed assets are derived from the alphabet soup of lending programs including $250 billion in commercial paper, $312 billion of Central Bank liquidity swaps and $236 billion in mortgage-backed securities.
Thus, our economy has become more addicted than ever to low interest rates. But because bank assets will now be collecting income at record low rates, when and if the Fed tries to raise rates it will only be able to do so on the margin. If Bernanke raises rates substantially to fight inflation, banks will be paying out more on deposits than they collect on their income streams. Couple that with their already distressed balances sheets and look out!
Additionally, not only do the consumers need low rates to keep their Financial Obligation Ratio low, but the Federal government also needs low rates to ensure interest rates on the skyrocketing national debt can be serviced. Our projected $1.8 trillion annual deficit stems from the belief that the government must expand its balance sheet as the consumer begins to deleverage. In fact, both the consumer and government need to deleverage for total debt relief to occur, else we’re just shuffling debts around and avoiding a healthy deleveraging entirely.
In order to have viable and sustainable growth total debt levels must decrease, savings must increase and interest rates must rise. But that would require an extended period of negative GDP growth-a completely untenable position for politicians of all stripes. Ben Bernanke would like you to believe inflation will be quiescent and he can vanquish it if it ever becomes a problem. Just make sure you don’t invest as though you believe him.
AT JESSE’S CAFE AMERICAIN: http://jessescrossroadscafe.blogspot.com/