Must Read from Huffpo's Robert Kuttner: Stimulus, Yes. Bank Bailout II, No.

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Robert KuttnerCo-Founder and Co-Editor of The American Prospect

Posted February 8, 2009

Stimulus, Yes; Bank Bailout II, No

While the compromise bill has too many concessions to tax cutters in both parties, at least the administration has the basic concept about right. The bill is clearly not just meant as a one-shot, but a down payment on more adequate social outlay and 21st century infrastructure. As the recession deepens, if Obama does his job he will mobilize public opinion and isolate Republicans who would rather sink the economy than give a Democratic president legislative success. The current recovery bill is a good first step.

The same, however, cannot be said about the even more important administration initiative, the revised bank rescue plan. If we get the scale of stimulus spending right, it will put people back to work and prevent the economy from collapsing for lack of purchasing power. But if the banking system stays in a state of cardiac arrest, it will continue dragging down the rest of the economy.

Treasury Secretary Tim Geithner has postponed unveiling details of the plan yet again, until Tuesday, citing the need to work on the stimulus legislation. But Geithner and other administration officials have already leaked enough details to make clear that they lack the nerve to do what needs to be done.

Geithner has gone out of his way to throw cold water on the idea of bank nationalization. Rather, the new plan will be some variation on the original strategy that former Treasury Hank Paulson sought and then rejected--getting toxic assets off bank books without asking a great deal in return. The plan reportedly will allocate $50-100 billion for mortgage relief, but here again this is to be done indirectly rather than through direct federal refinancing of distressed mortgages.

Here's the problem with this whole approach. The government has not been shy about telling banks what to do, but has done so in an ad hoc manner, without adequate information, without a strategic plan, and without the authority that goes with ownership. The Wall Street Journal recently published a devastating investigative account of how the Treasury Department ordered Bank of America to acquire Merrill Lynch, a deal that turned out to be a disaster for the acquiring bank. Executives were warned that if they did not go alone with the plan, the Journal reported, there would be hell to pay.

Basically, the government has been acting as if it owned the banks, but in a half-backed, scattershot manner. It would be far better to nationalize the large banks outright, sort out their balance sheets, and then decide what level of financial relief is required to get the banks functioning. This prevents the dilemma of government either overpaying for assets that are currently under water, or failing to provide enough aid. If government is the owner, then government actually runs the bank and there is no risk of windfall benefits to banks at taxpayer expense. When the banks are back on their feet, they can be sold to new private owners.

The current approach, apparently to be revised only slightly by Geithner, produces the worst of both worlds. Government is left holding the bag for the losses, but government lacks the direct tools to run the banks properly. On the mortgage front, it would be far more effective for government to simply refinance at-risk mortgages directly, as the government did in the 1930s under Roosevelt's Home Owners Loan Corporation.

Obama's problem is that his key economic appointees are averse to radical solutions to a radical crisis. Geithner and National Economic Council chief Larry Summers have both been quoted saying that governments "make poor bank managers." Geithner's own track record as point man for the rescue efforts of the Bush administration certainly proves his point, at least as far as his own work is concerned. But in fact, the Federal Deposit Insurance Corporation, which does take over failed banks from time to time, has an excellent record of sorting out their balance sheets, nursing them back to health, and then returning them to the private sector. The Treasury lacks this competence. This is all the more reason for government to build up the necessary expertise and then take over failed banks, rather than just pumping in money and intervening in fits and starts.

There is time to add more money to the stimulus package if the first attempt falls short. But time is fast running out on the more urgent need to get the banking system functioning.

Robert Kuttner is co-editor of The American Prospect. His latest book is "Obama's Challenge: America's Economic Crisis and the Power of a Transformative Presidency."

http://www.huffingtonpost.com/robert-kuttner/stimulus-yes-bank-bailout_b_165058.html

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1. Kick for this must read on the impending bank bailout!