Beyond the buzz words: $700 billion, bank rescues, partial nationalization, and what it all means
I interviewed two leading economists to find out. On Tuesday, when the “partial nationalization” of some of our country’s largest banks was announced, Henry Paulson’s most widely circulated quote was “Government owning a stake in any private U.S. company is objectionable to most Americans – me included…” But the alternative, no credit in the market, is “totally unacceptable,” according to Paulson. So what does this mean for us, American taxpayers?
Announcing the deal, Paulson explained, “…Treasury will make $250 billion in capital available to U.S. financial institutions in the form of preferred stock. Institutions that sell shares to the government will accept restrictions on executive compensation, including a clawback provision and a ban on golden parachutes during the period that Treasury holds equity issued through this program. In addition, taxpayers will not only own shares that should be paid back with a reasonable return, but also will receive warrants for common shares in participating institutions…”
I asked Linda Bilmes “what does partial nationalization mean-- is it a fair description”? Bilmes, who is a Harvard professor, former Assistant Secretary and Chief Financial Officer of the US Department of Commerce, and co-author of the Three Trillion Dollar War said “I think a lot of the buzz words floating around are completely wrong." The “bailout plan,” she noted, is not really $700 billion, it’s not a bailout, because it’s basically going to shore up the financial markets, and it’s not to Wall St. Ownership has been so disaggregated from the housing stock, she noted, it’s hard to say who owns what. “It’s us, it’s pension funds, a lot of institutional investors.” Put this way, we all have a stake in the bailout plan, even if it scares us.
On her blog, EconomistMom explained, “What makes it “nationalization” is that the federal government is effectively taking ownership of private equity.”
I spoke with Diane Lim Rogers, who is chief economist at the Concord Coalition and writes the great blog EconomistMom. Like Bilmes, she stressed that while the government is spending money it doesn’t have on the bailout bill, getting credit moving is key. She also stresses the need to seriously overhaul the U.S. financial system after we stem the current bleeding. And, as a “progressive deficit hawk,” she is supporting Barack Obama on November 4, because she feels he and his team have a more realistic plan to deal with the current, and future, financial crises.
Bilmes summarized the situation that led to the bank rescue plan succinctly: the story with the banks is that the credit markets have seized up because if the banks won’t lend to each other; then the whole system comes to a halt. Normally, Bank B lends to Bank A (and vice-versa), they lend to each other and that’s how they always cover each other. And they never know what their day-to-day needs will be…because businesses run on working capital, and so businesses will have different needs each day. One month a small (or large) business may be flush, and another they may need to access a line of credit. They need to go the bank when they need it. The only way this system works is if banks can lend to each other.
She notes of the bank plan, “I see it effectively as providing a sort of insurance to the banks. We’re saying to banks: we are putting a bunch of money in this bank. We are putting a bunch of cash on deposit. We’re going to give you guys all some money on the basis you start lending again.”
Bilmes noted also, “I don’t see it as nationalization- that’s a pejorative (in this country- Ed.). The Government is using cash (we don’t have) to essentially prop up the banking industry to provide lines of credit so businesses don’t fail. They are doing whatever it takes to keep credit flowing.” She believes the Feds are looking at what happened to Japan in the 80’s, when ironically the U.S. Government counseled against such drastic action. The Japanese economy eventually recovered, but the banks, she says, never recovered.
What happens now, I asked her? How do we ensure that credit does indeed get moving? “Nobody really knows. We absolutely need to get credit moving, quickly and fast. The theory is: we are all now shareholders, that’s where the nationalization comes in. We’ve bought a stake in these banks…much as the government of lower Saxony in Germany has a stake in Volkswagen and BMW.” We get more of a voice, but we don’t have voting shares and we don’t drive the business.
I asked her how we enforce the banks to start lending again, and Bilmes suggested it’s something of a game: “the feeling is, if banks see if we (the Government) put some money up, if things get into really bad shape, there’s more money. [The banks] have been now corralled into a room and have to play ball. If they don’t, then the question is, next time they want help from Government is the Government going to say, forget it? So the Government has more leverage by treating the major financial players in this country as a unit who’ve benefited, at least in the short term, from the U.S. taxpayers’ cash.
Finally, Bilmes stressed, “The biggest problem is the credit squeeze. The market is the sideshow. This is the place where they need to be moving right now." Referring to battlefield triage practices in Iraq, she said, it’s like treating the wounded soldier with an ice pack in Iraq before you can get him into surgery. But the big question is, after the election, are we going to get serious, dealing with entitlements, debt, spending and no national savings? Foreign governments are going to want to know we have a long-term solution before they keep shelling out dollars. A lot of things need to be watched.
Like Bilmes, Rogers is at least a little sanguine about the bank plan, because it uses some of the $700 billion bailout to give the taxpayers an equity stake. Rogers wrote the bank plan,
“doesn’t change the fact that the financial rescue will enlarge the federal debt. …What the new equity-stake plan does is gives the American taxpayer a little more promise of getting something back for the $700 billion. Instead of being told the $700 billion in additional public debt would “buy us” only “toxic assets” (bad debt), taxpayers can at least now find some comfort in receiving an ownership stake in more-tangible/measurable assets (decent equity). So for current and (more likely) future taxpayers, this morning’s plan should be viewed as a clear improvement in terms.”
I asked Rogers why the bank plan was announced after the initial $700 billion bailout drama. First, she noted, “The $700 billion number was pulled from the air. Paulson said it needed to be big, to make an impact. Nobody really knows why it’s $700 billion."
She continued, “My sense is this idea was around from the very first meeting on Capitol Hill, the idea of having an equity stake was around, but I think the Administration was reluctant to make it sound like more of a real intervention than just a financial system intervention. There’s the notion that they were opposed on philosophical grounds almost. Even though, in terms of the taxpayers’ position in all this, this is better than having a stake in nothing. [Before the bank deal] we already were told the Government had committed $700 billion but don’t worry- we’ll get some of it back. We were told the Government would just hold onto it, with no guarantee, no stake, nothing that told us return profits would come back to the Treasury.”
And what’s the end result, I asked. First, Rogers stressed, no one really knows. But she said, “I think two things come out of it- yeah government becomes a larger part of the economy, but we are headed for bigger government regardless. The other thing at least it’s giving us something a little more substantial in addition to the added $700 billion of federal debt.” It’s not clear exactly what this means, after all, we won’t get dividends if the banks do well, and hopefully it’s a temporary measure. (Clarification: this morning’s New York Times reports there will be a dividend payment to Treasury).
I asked, how do we ensure it gets credit flowing?
“Well,” Rogers said, “there’s real cash. The Fed issued more Treasury Debt. We’re just moving the debt around. We’re not getting rid of the problem that we have too much debt. But the Fed can borrow more readily. [The banks are] letting the Fed take on the debt and putting cash in private sector. And as long as the Fed is still able to borrow, it’s the easiest source of cash. It’s not sustainable over long term: interest rates will come up, and foreign investors will shy away. Echoing Bilmes, Rogers said, “Once we get consumption up to avoid a deep recession, once you get past this rough spot, and need to engage in life support, we have to start living within our means as a country. There is a short run strategy and a long-term strategy at play here.
The percentage of the deficit as GDP is a post-World War II record, at
7% of GDP. (correction: the % of GDP will be 7% if the predictions of a $1 trillion deficit for the fiscal year that just began (FY2009) comes true. Rogers says we must use this terrible experience as a wakeup call. “We as a nation need to save more. We are getting that as households, because our credit lines being taken away. But the federal government is not yet getting this. They are paying for this plan on debt and we have “maxed out our national credit card... The federal government can’t write off its own debt. The biggest problem is an economic problem. Running big budget deficits depletes national saving. Since 2001 we’ve been cutting taxes and it did not boost national saving and economic growth.”
Rogers stressed that politicians must not be afraid to be honest about the need to tighten our collective belts. It’s politically challenging to be fiscally disciplined. She laughs and says that she supports Obama but “We’re going to be all over an Obama administration. I won't let them get away with not coming through on their promises.”
For his part, Obama said yesterday, “The Treasury Department’s concept of investing money directly into struggling banks so they can lend money to families and businesses is the right one. But we must make sure this plan is implemented in a way that helps homeowners and does not enrich Wall Street CEOs at the taxpayers’ expense, something I have warned against from the first day of this financial crisis.”
As for McCain, the GOP candidate for President is calling for $52 billion in new spending to help the economy while promising that (no, really) we can balance the budget by 2013 AND keep the Bush tax cuts. That is pure fantasy.