The Trouble with Rescues and Stimulus

by: Diane Rogers November 02, 2008 | about stocks: GS / JPM / STT / WFC    

Diane Lim Rogers

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Having the federal government “rescue” or “stimulate” the U.S. economy isn’t an easy thing to do.  In Friday’s Washington Post, Steven Pearlstein writes of “Hank Paulson’s $125 billion mistake.” 

That would be referring to the $125 billion in new capital provided by Treasury to the nine biggest banks, in what was billed as ”partial nationalization.”  (Hard to believe that was just a couple weeks ago.)  My view at the time was that having the federal government hold some sort of equity stake in these banks was at least better than having no stake at all and holding only “bad paper” (sometimes referred to, oxymoronically, as ”toxic assets”).  But Steven explains why some who advocated the move now think it’s not going so well:

Now, many of the same people are shocked — shocked! — to discover that the banks aren’t using the money to make new loans to households and businesses, as they had assumed, but are using it to maintain dividend payments to shareholders, pay this year’s bonuses to executives and traders, or squirrel it away for future acquisitions.

I hate to say it, but I told you so. Sprinkling money around a highly fragmented banking system when markets were panicked and everyone was scrambling to reduce leverage was always akin to shoveling sand against the tide…

[M]aking modest investments in dozens of banks, whether they needed it or not, produces little for the public beyond the small profit for the Treasury. What it does do, however, is open the door for every politician and populist to second-guess every decision and expenditure the banks make, based on the false assumption that everything they do is with “our money.”

In other words, it is still just partial nationalization, and market prices and private profit-seeking are still the major forces at work.  Just because the government is effectively a shareholder now, doesn’t mean the government can actually control how these banks choose to run their businesses. 

Then Steven goes on in a way that leads my mind to wander past the banks and the government’s $125 billion “mistake”…

[I]n trying to persuade banks that don’t need the money to take it, the Treasury has wound up offering everyone the same sweetheart deal that gives the government little say in how the money is used or how the banks are run. That’s particularly dangerous in the case of weaker banks, which might be tempted to take big risks in the hope of recouping past losses or to divert money to shareholders and executives before the inevitable government takeover.

In the case of some of the stronger banks, however, much of the carping about bonuses and dividends and refusal to lend are a bit overblown…

…and which leads me to wonder:  if we’re worried that the $125 billion “partial nationalization” of the biggest banks could turn out to be a “mistake”–because the government has little control over how the money gets used by the assisted industry–then might this be just the first of many mistakes to come?  

Gee, look at that story in the paper right next to the continuation of Steven’s column on page D6, “Government Urged to Help Auto Industry“… and the story in yesterday’s Washington Post about how Michigan voters have been unusually sympathetic to the $700 billion rescue plan, “in large part because voters think the auto industry needs a similar boost.”

Steven seems to think the worries about the lack of new lending are overblown.  He reminds us that the banking industry has not really been nationalized (not fully, and maybe that means not really at all–like a woman can’t be partially or sort of pregnant?), and that what we’re really worrying about here is that some of the money is being saved rather than lent out:

[B]anks like J.P. Morgan (JPM), Wells Fargo (WFC), State Street (STT) and the newly chartered Goldman Sachs (GS) remain highly profitable and well-capitalized. It ought to be up to them to decide whether to use those profits to add to capital reserves or pay them out in dividends and executive bonuses. We might not like their choices, or their values, but this is still a market economy, and these are still shareholder-owned companies. The industry hasn’t been nationalized just yet.

It is also useful to remember that the way banks make money is to lend it out, not hold it in the vault or invest it in low-yielding Treasury bonds. Hoarding is not generally a winning strategy for maximizing share prices or executive bonuses. It is also useful to remember what got us into this mess in the first place. If banks are using their new capital to reduce their own leverage, or are more cautious about whom they lend to, that’s probably a good thing.

Yes, there’s what I’ve talked about a lot before–the really tricky thing about immediately “stimulating” the economy (boosting consumption) given what brought us to the more fundamental and longer-lasting “mess” in the economy as a whole (too much consumption/too little saving).  It’s a very general challenge in the current economic climate:  how can we ”rescue” and “stimulate” the economy without encouraging the “living beyond our means” mentality that is so harmful to the longer-term health of our economy?  (The Concord Coalition suggested some ways to think about it in our recent issue brief.) 

It’s interesting that a Business section story in yesterday’s Washington Post on stimulus ideas highlights the contrary short-term versus long-term prescriptions, in listing the “downsides” of many of the stimulus proposals as they might decrease national saving!  (…which is actually what we want it to do, at least in the short run.)

Then Steven wraps up his column as if he’s known all along where my thinking was going, especially with my recent preoccupation with the auto industry:

Perhaps the worst part of this misguided effort to recapitalize the banking system is that it has prompted other industries to line up for similar sweetheart deals. Automakers, insurers, auto finance companies and local governments are already besieging the Treasury, and you can be sure that others are refining their pitch. One can only hope that the terms of future deals will be sufficiently onerous that going to the Treasury will become a last resort, not a first instinct, for industries in trouble.

That’s the basic (and tough) challenge facing policymakers (when they come back for the lame duck session after the election): how to get federal support out there in our economy where it will make a difference and where it will turn out to have been “worth it” to current and future taxpayers.

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This article has 5 comments:

  •  
    Nov 02 08:14 AM
    Congress and the senate take to much time off,regular workers
    don't get to do that. And we don't get to increase our earning
    like they do.
    And that all needs to be changed up.

    11,2,2008 7:14 AM
    Reply | Link to Comment
  •  
    Nov 02 08:56 AM
    [how can we ”rescue” and “stimulate” the economy without encouraging the “living beyond our means” mentality that is so harmful to the longer-term health of our economy?]

    We can't- those two objectives are mutually exclusive.

    Criticizing the banks for not immediately lending the money seems crazy to me.

    Did they inject this capital to improve the health of the institutions? If so, then they should be allowed to decide how best to do that.

    Taking that money and immediately loaning it just because they were scolded would later be seen as irresponsible. Then the legislators would have to castigate the banking industry for "making the problem worse."

    You can't win when you have ignorant people deciding how we're going to "fix" the problem with government money.
    Reply | Link to Comment
  •  
    Nov 02 10:18 AM
    Wells Fargo’s Chairman, Dick Kovacevich, was fit to be tied at the meeting with Bernanke; he did NOT want to sign the documents giving the Feds any ownership or “say” in Wells Fargo & Co, he did NOT want the money.

    It took the rest of the CEO in attendance, especially Ken Lewis, to convince him to “go along” with the plan “for the good of others”. He was told that if he decided to “op-out” he would look like he was “un American”. He and the others were told by Bernanke that “they had little to say about it”, if they didn’t take the money and sign the agreement THAT DAY, they would suffer the consequences (in so many words). Treasury Secretary Henry Paulson basically told the bank CEOs that they had to accept the government stock purchases for the good of the U.S. economy.
    Reply | Link to Comment
  •  
    Nov 02 04:08 PM
    Our macro econonmic problems can never be wholly solved. They can only be ameliorated. There are no solutions, only "trade offs" which at best maximize advantages and minimize disadvantages. we will in the end, nationalize the banks and revert to a "command economy". We will increasingly move toward economic isolation in the world markets, and perhaps into a totalitarian mold.
    Reply | Link to Comment
  •  
    Nov 02 09:11 PM
    I echo "I should know"'s comments completely. WFC didn't want the money. Should their shareholders suffer? The author should perhaps do her research.
    Reply | Link to Comment
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