Saturday, April 11, 2009

Scapegoats, Red Herrings, and Zombie Banks

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by Kevin Van Dyke

The last 10 days has been anything but roses for the Obama administration. While the AIG bonuses are largely irrelevant in the whole scheme of things, they are a symptom of a potential larger problem facing this administration.

The AIG Distraction–How does it play in Connecticut?

When news first broke about the shenanigans at AIG that were allowable because of bonus restrictions being stripped from the bailout bill, the White House pointed a finger at already embattled Connecticut Senator, and member of the Countrywide VIP Club, Chris Dodd. Because Chris Dodd, like Chuck Schumer and most of the congressional delegations of New York and Connecticut, is easily influenced by the Wall Street hacks, Dodd was an easy scapegoat. To Dodd’s much maligned credit (pardon the pun), he and others would be hard pressed to be anything other than such friends of Wall Street when such a large percentage of their constituents are so reliant on Wall Street for their bread and caviar.

However unscrupulous Dodd may or may not be, there was a little fact about this story that the Obama administration apparently forgot to mention. It was their men, Tim Geithner and Larry Summers, who had lobbied Dodd to strip the bonus restrictions in the first place. Senator Dodd, of course, was quick to point this out. While Geithner, Summers, and team have had barely two months to formulate a response, their ineptness to even get out of the batter’s box lately makes one wonder if Obama may have sacrificed the wrong lamb when it came to tax issues. It sure seems now that Timothy Geithner may have been a better fall guy.

What’s the Dilemma Guys?

When AIG isn’t being blamed for all of our current troubles, it’s the lobbyists. The Obama administration’s response to this situation seems to be an insistence on having it both ways. They claim the “change” mantle and a new way of doing things in Washington, but yet at the same time, they are finding that it is virtually impossible to field a competent staff to address the unparalleled challenges facing our country without hiring at least some experts who have spent some time lobbying. Virtually all of those who have had previous government experience have spent at least some time in some lobbying function. “The rotating door” is alive and well and will take decades to remedy. While efforts at stopping this trend in the long run are noble ideas, suddenly stopping this trend to hire those without any type of lobbying experience means that you de facto are eliminating most of those who have any previous top-level government experience. Of course, new blood is surely needed, but to staff the entire upper strata of government with neophytes in this current environment makes little sense. Therefore, while lobbyists may be good bogeymen to go with the AIG executives, they seem to be the least of our worries. The bigger issue seems to be an utter lack of political will on behalf of the Obama administration and many in the United States Congress.

Socialists and Communists, Oh No!

Just as no Democrat could go to China during the Cold War (Dick Nixon of course could), it seems that no Democrat can muster up the political will to do what is right–temporarily nationalize several of the larger banks. This is something that has been called for by many liberal (in the economic, free market sense) economists and publications such as The Economist. This is anything but a fringe idea.

Instead, Tim Geithner announced today that the government will form “public-private partnerships” to help out the banks. The problem with this approach is is that many economists seem to doubt that the private sector will in fact buy much of these assets. In fact, the plan basically entails the government subsidizing private investors to buy bad assets. If the assets are in fact undervalued (as Geithner is betting the farm on), then the private investors will make it rich off of Uncle Sam’s dime. (Of course, this would also likely mean the economy would likely start rolling again and millions of jobs may reappear–presto!) However, if the assets are not really undervalued, as Paul Krugman speculates, then these private investors will simply walk away from the losses. It seems to be more of the same–the public bearing the risk with investors reaping most of the benefits. It certainly sounds good for Wall Street–the Dow was up 500 points today!

To Geithner’s credit, he also mentioned today that there must be new regulations put in place that stop the same moral hazards that got us into this mess in the first place. The problem is that these regulations seem to be something to eventually get around to in the future. In the meantime, more of our tax dollars are going to prop up zombie banks, without much control over where the money goes. In other words, the same people who got us into this mess are still running the same companies under the same set of rules that existed for the last decade. Plus, we’re giving them more money to boot! Does anyone see a problem with this?

Is it possible that the Obama administration cannot possibly do what is economically necessary because of a fear of being called socialists? For God’s sake, they were called socialists during the entire election season and still won in a landslide. If anything, this was a landslide of socialism. You might as well own it if it what is necessary for national economic recovery. As a free marketer and University of Chicago grad, I, of course, am not a big fan of long-term government interruption of the markets. However, I also am not a fan of zombie banks being propped up by the government. The best economic (although apparently not political) solution seems to be obvious. These banks need to be temporarily taken over, divvied up, sacked of most management, and sold off once solvent again. If this is not done, we risk the chance of a lost decade similar to what Japan faced in the 1990s. Temporary nationalization sure beats a decade of no growth.

But instead, the Obama administration, lead by friends of Wall Street within the administration and Congress, apparently plan to do what’s best for the executives and what seems to be politically palatable. However, like it or not, if the economy fails to rebound in a few years, the Obama administration will be blamed for it. It’s as simple as this. They must do what’s necessary to turn around the economy, no matter what labels it may lead to. They must be bold. They must be independent. They must shed away fears of socialism and embrace what’s right. Because, in fact, showing that companies that fail will not be allowed to survive is anything but socialism. It is the true nature of the free market. Without such consequences, we encourage moral hazard and the adverse behavior that have plagued our markets in recent years. Those who make bad decisions must be held accountable for their actions. Those who fail must be allowed to fail so that there is room for the new best ideas to flourish. Every so often it is necessary to flush out the waste to achieve new growth. Sometimes government is the only entity with the buying power to successfully flush out this waste while avoiding complete economic collapse.

It is not the ideal situation. But it is the best worst option in these worst of times. It is about time the Obama administration be honest with the American people and do what’s right for everyone, not just for those in Manhattan and Connecticut. It’s time for the best economic solution for the future of our country, even if it’s not the best short-term political decision. This is what real leadership would entail. This is what real change would look like.

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