Roubini wishes Obama had done it all

Nouriel Roubini may have a keen macroeconomic insight into what the world economy needs and what the U.S. economy needs. But he has little appreciation for the realities of U.S. politics. Or rather, he suppresses his awareness of those realities while assessing the performance of President Obama.

In his contribution to the Financial Times' series of such assessments (Obama at Bay), Roubini credits Obama with preventing another Depression, via the stimulus and the bailouts, and with understanding the need for more stimulus now and a timed plan for deficit reduction later. He also gives him points for forming the deficit commission. He blames the President, though, for what has not happened and what will not happen:

In an ideal world Mr Obama would also have been able to move towards reforming and reducing entitlement spending, with commitments to measures that could be phased in over the next few years, therefore avoiding short-term fiscal pain. He would also have committed to increase, gradually over the next few years, less distortionary taxes such as a VAT and a carbon tax. This would have reduced the fiscal deficit, and created a climate in which no investor would worry about additional stimulus.

Sadly, this has not happened. In fact the opposite will now take place. The term stimulus is already a dirty word, even within the Obama administration. After the Republicans make significant electoral gains further stimulus is even less likely. Medium-term consolidation, meanwhile, will be all but impossible as the 2012 presidential election begins to loom large.

Mitch McConnell, bank-shrinker?

Ezra Klein has beat me to it again.  Today Mitch McConnell came out against Dodd's bank reform bill,  claiming that by setting up and funding a resolution authority that enables regulators to liquidate the largest financial institutions in an orderly fashion if they become insolvent, it is enabling and in fact guaranteeing future "bailouts." "“This bill not only allows for taxpayer-funded bailouts of Wall Street banks;  it institutionalizes them,” McConnell pronounced.

Klein points out that McDonnell is equating a liquidation that wipes out shareholders and management with a bailout -- and further notes that McDonnell is following to the letter a political strategy laid out by GOP pollster Frank Luntz in February: to equate any Democratic bank reform bill with the hated bailouts of 2008-09.

Cynical indeed. As Klein suggests, if you don't want to give regulators resolution authority over banks currently considered too big too fail, it would seem you would have to be in favor of not allowing banks to grow, or stay, too big to fail.   I would add that the only intellectually consistent, if insane, alternative to  breaking up, shrinking, or reining in today's behemoths or making provisions for their orderly liquidation is to take the position taken by many of the most ignorant and extremist Republicans in fall 2008: let 'em all fail and let the chips fall where they may. Pull down the whole temple of global finance around our ears.

But McConnell is not that crazy. He acknowledged last October that TARP “succeeded in stabilizing the banking system.” It seems fair to assume that he believes that the Federal government can't simply step back and let too-big-to-fail banks enter bankruptcy. That brings us back to Klein's question:  what steps would McConnell favor to make the behemoths smaller, or otherwise enable them to fail without systemic risk?

Geithner: man with a plan

I will cop to having no economic basis to judge whether Timothy Geithner's plan to create a market for today's "toxic" debt securities will work. But Salon's Andrew Leonard has the right take on how Geithner -- and by extension, Obama -- have handled the process of forging policy:

From the very beginning, when Paulson told us that the subprime meltdown would be contained, to the very end of his tenure, there was never the sense that the Bush administration had a coherent strategy of any kind.

The same cannot be said of the Obama administration. Geithner's plan may well not work, and it may be too beholden to Wall Street, but its rollout has not been an exercise in helter-skelter chaos. In dealing with the economic crisis as a whole, the Obama administration has put into play a steady flow of initiatives that should, in theory, all work together. In addition to the stimulus, the housing plan and credit relief for small businesses, there's also been a budget proposal addressing long-term issues that even Paul Krugman found impossible not to praise. The Fed has been doing its part by engaging in its own extraordinarily broad-scale stimulative monetary policy.

All along, it has been universally agreed that the most glaring weakness of the Obama portfolio has been the lack of detail on how Geithner intended to tackle the banking system. But there is a difference between a lack of detail and utterly contradictory confusion. If we can hold our breath long enough to calmly assess the last two months, one can see that amid all the noise, the Obama administration has been moving carefully forward in one direction.

Geithner was very careful not to pin himself down on details during his confirmation hearing, except to say that the goal of his eventual plan would be to encourage more lending than would otherwise happen without government intervention. His first speech was widely criticized because he neither endorsed bank nationalization or provided enough detail for Wall Street to chew on. But ever since that speech, he's done pretty much exactly what he said he would do. The banks are being stress tested to determine their ability to survive an even worse downturn than we are currently experiencing. Capital will be made available to them to weather that storm. A "public-private" venture to create a market for toxic assets has been laid out. We have timelines and we have a strategy. The scheme outlined in the Treasury Department's White Paper may share an intellectual heritage with Hank Paulson's original cockeyed dream -- except for a rather large difference. It exists. It is real. It will either work or it will not.

I suspect that when the history of this financial crisis is written, Obama and co. will be seen to have steered a rational course, shaped largely by a terrifying inside view of the risks of systemic failure -- and that their decision making process will be recognized as reality-based, adjusting to failures as they happen, embracing complexity, and unswayed by ferocious criticism on all sides.

Which is not to say that those who claim it's futile to try to find value in the toxic assets or prop megabanks that may prove to be insolvent are not right. Here, too, Leonard has perfect pitch:

There is every reason to believe it will not work, and may even make things worse. There is every reason to doubt the fundamental assumption being made by the Treasury -- that the "true" value of the toxic assets is higher than their current market value...

But all the sturm-und-drang expressed hither and yon about how the Obama administration is damning us all to a decade or more of economic doldrums by not pursuing immediate bank nationalization today, is just a bit overwrought. The U.S. economy is not going to stop shedding a half million jobs a month if we nationalize Citigroup today, instead of two months from now. We are deep in a recession and it will be quite awhile before we crawl out of it. Two months of caution do not mandate a "lost decade." Indeed, we will know in a matter of months whether the Obama administration's current efforts are gaining any traction, and if they aren't, then there will be no other alternatives. Perhaps the smartest thing that Geithner's critics could do is to just step aside and let him fail.

It's worth keeping in mind in this context that Nouriel Roubini, while forecasting/advocating the nationalization of a number of large banks, suggested that the time won't be ripe for approximately six months. I sometimes suspect that Obama, if not Geithner, suspects or knows that several of the largest banks can't be saved and is preparing the ground for the moment when nationalization emerges as "the worst possible option except for all the alternatives." If so, he would follow Roosevelt entering World War II and Lincoln issuing the Emancipation Proclamation - waiting for the moment when he can forge consensus around the inevitable.

One (possible) reason Geithner's not nationalizing...yet

Some advocates of bank nationalization make it sound quick and easy -- get in, clean up, get out. As for wiped out shareholders and damaged bondholders - tant pis, taxpayers come first.

FinanciaWeek's editor Ron Fink today offers a credible glimpse at one major complicating factor. Certain bondholders may command a strong measure of consideration:

Although it is impossible to prove their contention based on publicly available data, [some] analysts suspect that China’s holdings of the debt of banks such as Citigroup and Bank of America are one reason the Obama Administration is hesitating to take over those banks and restructure them with taxpayer assistance.

Although an increasing number of experts contend temporary nationalization followed by a spin-off of the banks’ good assets to private investors would be the most effective way to resolve their financial woes, that would wipe out the value of current shareholders’ holdings. What’s more, nationalization would force bondholders to take a substantial hit.

The U.S. government, these analysts say, is simply unwilling to subject Chinese financial institutions to such losses, particularly at a time when Uncle Sam needs these overseas lenders to finance America’s growing deficits through Treasury bond purchases. While China needs these purchases to hedge its exposure to the dollar as a result of its reliance on exports, Beijing has been shifting its capital investment priorities from exports to domestic infrastructure—not surprising given U.S. imports have fallen during the recession.

The Chinese continue to buy U.S. debt, Fink notes, in large part because it's in their interest to support the dollar and so maintain the value of their export income. At the same time, Beijing is "shifting its capital investment priorities from exports to domestic infrastructure." A loss of what could be in excess of $150 billion on U.S. bank debt, triggered by nationalization, might prompt a more sudden Chinese turn away from Treasury bond purchases.

Nouriel Roubini, one advocate of nationalization who doesn't mince the difficulties, has suggested that the time won't be ripe for another six-odd months, when it's clear which banks are insolvent and nationalization of the largest insolvent banks can be done "at one fell swoop." The China hypothesis suggests another powerful motive to make haste slowly on this front:

[Brad] Setser noted that.... he wouldn’t be surprised if China were trying to reduce its exposure to the debt of Citi and B of A. “Post Lehman, post [Fannie and Freddie], it seems like China is shifting back into Treasuries quite quickly,” he wrote.

So if the scenario that played out at Fannie and Freddie scenario is any indication, the Obama administration may be waiting for China to reduce its exposure to the debt of the latest U.S. financial institutions found lying near death’s door before it nationalizes them.

Geithner may have got off on the wrong foot but he's no fool. It's neither ideology nor timidity that's holding back a bank cleanup. It's likely a matter of timing, damage control, first doing no harm, and minimizing unintended consequences. Drugs and exercise before radical surgery.