At the end of the third week of February, Senators Dodd and Schumer signaled that financial elite solidarity had broken; “nationalization” is no longer taboo. The consensus is dead (check with Barney Frank), crazy ideas abound, and long live what new policy approach? Here are five sets of issues to guide your viewing the week of February 23 as we slip and slide sideways into our future.
- The White House and Treasury have fallen behind events. When and how do they try to regain control of the situation? Is there a relatively early and decisive move up their sleeves? This seems difficult, as they have committed to doing stress tests first and foremost, and presumably any meaningful tests take at least a week (probably they were intended, when announced, to buy more than a month). But these are resourceful and imaginative people, with lots of connections and some big friends to save, and they fully understand the importance of retaking the initiative. Watch for a major announcement early in the week.
- The strategy alluded to by the Senators is: The devil take the hindmost. This implies two big banks are in the line of fire; both, of course, are strenuously denying that anything of the kind is true (we could call this the Irish Ministry of Finance line; it also worked for Northern Rock and Iceland, at least for a while). But the banking system problems are likely to be much deeper, and any attempt to deal with just two banks is likely to founder fairly quickly. Probably our financial leadership will for now dig in around “two and only two,” but when the consensus is so fragmented, anything can happen. Follow the public statements of Lloyd Blankfein closely; use the hubris in his February 8, 2009, Financial Times op-ed as a benchmark (remember: this was timed to appear upstage on the morning Secretary Geithner was supposed to present his financial system plan).
- How does the designated government leadership communicate that credit probably needs to contract for all banks, including anything taken over by the government, given the declining willingness to borrow by creditworthy individuals and firms? Some of the language used in and around the House Financial Services Committee hearing with bankers demonstrated a worrying misperception—just because banks are taken over does not mean they should, could, or would increase lending. If we get a substantial increase in government directed credit, our problems will get much worse before, if ever, they get better. This is definitely a media blitz assignment for senior political nominees at Treasury. Will we learn more of their names this week?
- There is no panacea, and that includes taking over banks. We face a pervasive global confidence problem for consumers, firms and—in some countries—governments. The government takeover of failed banks with systemic importance is the worst of all possible strategies, apart from all the alternatives. Decisive action on the banking system is necessary but not sufficient for the economic recovery. Will this message be communicated clearly by the architects of the bank strategy, to keep expectations at reasonable levels? Could someone, please, have a word with the official forecasters (yes, I’m looking at the Federal Reserve). It is hard to focus the world (and Congress) on forestalling Financial Armageddon when your crack modelers publicly predict something close to a V-shaped recovery near the end of the forecast horizon.
- Will there be a clear, upfront commitment to reprivatization, with a promise that large banks will be broken up in the process? Changing the industrial structure of banking is essential for altering the political economy of the sector. Community bankers—influential in the Senate—need to be brought onside with aggressive FDIC-type interventions, and this is more likely to happen if they sense that that the era of megabanks is drawing to a close (the dinosaurs are finished; someone notify the mammals). Watch also for supportive body language among private equity investors. If the banking lobby breaks into small pieces, politics could become a lot more interesting.
Also posted on Simon Johnson’s blog,