Back To Basics

I would like to return to something Matt Stoller wrote in The Big Banks Win Again. I quoted it in Saturday's post A Rounding Error For Banks. This post is also a follow-up to yesterday's The United States Of Denial.

Rather than settling anything, this agreement is simply a continuation of the policy framework of both the Bush and the Obama administrations. So what, exactly, is that framework? It is, as Damon Silvers of the Congressional Oversight Panel, which monitored the bailouts, once put it, to preserve the capital structures of the largest banks. “We can either have a rational resolution to the foreclosure crisis or we can preserve the capital structure of the banks,” said Silvers in October, 2010. “We can’t do both.” Writing down debt that cannot be paid back — the approach Franklin Roosevelt took — is off the table, as it would jeopardize the equity keeping those banks afloat.

This policy framework isn’t obvious, because it isn’t admissible in polite company. Nonetheless, it occasionally gets out.  Back in August 2010, at an “on background” briefing of financial bloggers, Treasury officials admitted that the point of its housing programs were to space out foreclosures so that banks could absorb smaller shocks to their balance sheets. This is consistent with the president’s own words a few months later.

To preserve the capital structures of the largest banks. Stoller writes that this policy framework "isn't obvious, because it isn't admissible in polite company." I beg to differ. This policy framework has been obvious since the day Lehman failed. Of course, DOTE isn't polite company. But I am not here to argue with Stoller, who is 100% correct otherwise.

Banks exist (or should exist) to loan out money—not gamble on oil, foreign currencies, derivatives, mortgage-backed securities or anything else. A bank is not a casino. In a properly functioning capitalist economy, banks are utilities like an electric company. When credit is extended, debt is created. What could be simpler? If that debt serves a useful purpose, i.e., creates wealth, the economy grows.

The debt created before and during the Housing Bubble didn't create wealth. It appeared to create wealth as long as people traded houses, but that was not real wealth. Now American households are awash in debt. I am simplifying, but we might ask what then is the point of preserving the capital structures of the largest banks? American households need income, not more debt.

There is no point to preserving the capital structures of the largest banks. When Lehman was allowed to fail, and the other Big Banks seized up because of the risks they took, they should have been allowed to fail gracefully. Capitalism without failure is like religion without sin. The banks should have been broken up and their good assets redistributed, and household debt which can not be paid back should have been written off. (Stoller cites Roosevelt on this point.)

We should have started all over again with a clean slate. It's the only way. Those who cite the "moral hazard" of helping out those who took inordinate risks by taking on mortgages they could not afford should realize that everybody would be better off in the long run if we had started out fresh.

The reason we didn't start over again with a clean slate is due to one overarching factor and one secondary consideration. The main fact we all have to live with is that the government is corrupt. It is subservient to the money the largest banks give to politicians. (I could generalize this to all special interests, but let's stick to banks.) Therefore the goal of the government was to preserve the capital structure of the largest banks, and homeowners be damned. This is why Tim Geithner is Secretary of the Treasury. This is why Larry Summers, who recently wrote that no big bank anywhere in the world should be allowed to fail, was hired to be Obama's chief economic adviser. I could go on and on here, but we're getting back to basics.

The secondary consideration is neo-Keynesian economic theory (Steve Keen's term). This "framework" discounts the importance of private (and public) debt in how the economy functions. Thus does neo-Keynesian theory rationalize preserving the capitial structure of the largest banks.  Policy drives economic theory, not the other way around. Neo-Keynesian models are the handmaidens of our corrupt government's "policy framework."  This is why it is a secondary consideration. It is good to know this, for it means you can just start laughing anytime somebody starts talking about jump-starting the economy through credit expansion.

All of the above is an over-simplified but fair description of the world we live in today. The six largest banks—Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley and Wells Fargo—are larger and more powerful today than they were before the financial crisis. Our government's policy framework, which isn't admissible in polite company, should be Front Page News every day of every week. I don't like quoting Abraham Lincoln in this sordid context, but here it is.

... that this nation, under God, shall have a new birth of freedom—and that government of the people, by the people, for the people, shall not perish from the earth.

We do not have government of the people, by the people and for the people. If not from this Earth, a new birth of freedom has perished in the United States. And that's what getting back to basics means. If this is not obvious in 2012, I don't know what would be.

Comments

[Honesty]

"for it means you can just start laughing anytime somebody starts talking about jump-starting the economy through credit expansion."

Oh cmon' Dave, according Paul Krugman debt doesn't matter.