The Bankers' Dirty Little Secrets

The excitement about the release of the information from the stress tests later this week (admittedly already bubbling out) almost definitely belies the likely dullness of the information that’ll be provided – at least to most of us who do not have advanced degrees in economics. The complexity and strangeness of the issue is probably best shown by the fact that people are complaining on the one hand that the bankers have too much power, that the administration has been turned into a lackey of unrepentant masters of the universe; and on the other hand that banks are unhappy about the fact that so many of them are likely to fail the tests and be forced to borrow more from the state. In one version a bailout from government is lining the pockets of the wealthy; in another it’s some kind of punishment. Go figure...

In fact, this is not surprising when a government has to intervene to prop up failing businesses that are too important to the economy as a whole to be allowed to fail. On the one hand, we want to punish those people who we blame for the initial failure so as to create moral hazard; on the other, we don’t want to be so harsh that we don’t actually help the businesses, since if we don’t get them working again we’re just hurting ourselves. Ideally, a chorus of complaints from both sides of the argument is the noise we should want to hear come Thursday: this would be a sign that the balance of the Obama-Geithner measures are just about right.

The function of the stress tests are two-fold: one, to restore general public confidence in the banks, something that has been noticeably absent since before the election but is oozing back; and two, to restore confidence between the banks, so that the interbank lending rate will readjust toward the general rate of inflation and so on (thereby allowing the Fed’s basic mechanism of macroeconomic policy to start working again). In this sense, the exercise is one vast forced expose of the banking sector’s dirty little secrets in the hope that we can then get over them and move on. No wonder the bankers are unhappy.

Moreover, by holding out the requirement that banks falling below a certain level will be required to take government money (something the leading bankers know will dent their comparative standing in the market), the government has both a weapon to use against recalcitrant bankers and a way of reassuring the public that the banks are not going to fail.

This, then, is a good thing. During FDR’s successful reconstruction of the banking sector when he took office, he did a pretty similar exercise, albeit in a slightly more back-of-the-envelope way. First, he used the Trading With the Enemy Act to declare a national bank holiday and told the public that his people would use this time to conduct intensive examinations of the banking sector. Second, the Reconstruction Finance Corporation set up by Herbert Hoover was instructed to print loads of money and lend it to banks to keep them afloat - not for the banks' benefit, but so people wouldn't withdraw all their savings and crash the system. After a week, Roosevelt appeared on the radio to inform the public that the banks were solvent, conservative and protected, and so they should not rush to withdraw any more money. (Though of course, in a classic banking paradox, it was only the belief in their solvency that actually gave them solvency.) Within a month, more than 70% of the banks in the country had been reopened without any accompanying runs, and in the end the RFC lost only about $13.6m through failures.

From this perspective, then, I don’t think we need to worry too much about people who are complaining that Geithner and Obama are in the pockets of the bankers. Actually, they’re just following tried and trusted methods to restore confidence in a failed marketplace.

But that’s not the end of the story, because it’s not enough just to rebuild the old, flawed, radical banking sector and watch it fall over again under the next neoliberal administration. We need the banks to be working for us all, not just for the ultra-rich. We need a nice conservative, stable bunch of bankers, not a chorus line of Dolce and Gabbana wearing Gordon Geckos snorting cocaine through thousand dollar bills they’ve stolen from old ladies' pockets...

This is why Obama must follow up with the same fourth step that FDR took after rebuilding the system: substantial new regulation of the banking sector to eliminate the unholy profit a few people have managed to make from our savings and investments in the past thirty years. Indeed, given the amount of deregulation that's been passed since the 1980s which was aimed directly at New Deal measures, perhaps simply passing the 1933 and 1935 Banking Acts word for word once again might do the job!)

I’m no expert, but it seems that two elements are absolutely critical: first, the reimposition of the Glass-Steagall separation of commercial and investment banking; and second, the raising of mandatory reserves for commercial bankers in order substantially to reduce the scale of leveraging. This makes money less cheap, true, but also makes it more secure.

A third element would be to dramatically increase the requirements on public release of information from these corporations so that we’re not forced to rely on external firms to tell us whether we can trust them or not. I’m all for making them utterly transparent. When it comes to banking and marriage, dirty little secrets are no good for anyone. And, finally, I doubt many of us would lose sleep if efforts are made to drastically limit the scale of pay and bonuses at the top of the tree. Over time, these measures should come together to perform the same confidence-building function as the government money has done so far, which can then be slowly paid off.

It’s a difficult balancing act, but it’s actually something that the United States has a pretty good history of dealing with. For better or worse, American politicians have been fighting the bankers since the Age of Jackson, if not of Alexander Hamilton. With an administration that seems to have a real sense of history behind it, this will serve the whole of the United States pretty well...

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