The Wall Street Journal's "Mean Street" columnist, Evan Newmark, calls Hank Paulson a "national hero" for achieving a "sotto voce nationalization of the U.S. banking system." Like the cold warrior Nixon making overtures to China, says Newmark, only a "wealthy Wall Street CEO" could have convinced his brethren to sign on the dotted line of the term sheets Paulson passed out in his meeting with nine bank chieftains on Monday.
It's possible that future economic historians will look back at the current crisis and lionize Paulson. I think it's far more likely that they will see him as someone whose hand was forced by the failure of his previous measures and by the dramatic steps taken in Europe to address the crisis. Future historians are also likely to focus just as much, or more, on how Wall Street banks, under the leadership of Hank Paulson and his band of credit-swapping brothers, helped to create the current mess, than they are on how the former CEO of Goldman Sachs tried to fix it.
But that's the future. What about the now? On Wednesday both the the New York Times and Wall Street Journal ran fly-on-the-wall accounts of how the big meeting between the government and the nine bank CEOs went down. All very interesting as a demonstration of Paulson and Bernanke's ability to force billions of dollars of government money down the banking industry's throat, but still leaving one very major question unanswered: What is the mechanism for ensuring that the banks take the cash and do with it what the government wants: make loans?
Felix Salmon asked precisely this question Tuesday afternoon:
America's banks -- and the world's, for that matter -- have had de facto unlimited access to very cheap Fed liquidity for many months now. That hasn't induced them to lend. Will this latest recapitalization do the trick? I'm far from convinced. And what's more, the demand for loans is drying up fast: do you really feel like buying a bigger house right now, or taking out a car loan? Well, businesses are in the same boat. In a recession, their ROI falls, so they borrow less.
With less demand for money, and no real desire on the part of the banks to lend it out, I think it'll take more than hand-waving statements from the Treasury secretary to get the credit markets moving again. I do hope that Paulson is looking one step ahead here, and coming up with ways to compel the banks to lend -- even if they don't particularly want to.
It's a good question, but Georgetown's Adam Levitin asks an even better one: Do we really want to force banks to lend, and run the risk of creating an even bigger credit bubble? His summary of the current dilemma facing policymakers is devastating:
The U.S. economy is fueled by consumer spending. In order for the economy to grow, consumer spending has to grow, and consumer spending is fueled by debt. Consumers largely spend not out of current assets or current income, but out of future income. Consumers are able to do this because of their assumptions about their current assets -- especially their retirement savings. Unfortunately, consumer behavior for the past seven years has been shaped by the unrealistic expectations formed in a bubble. Consumers have saved less because they thought they had a bigger investment cushion. This sets us up for a retrenchment in consumer spending, which is exactly what Treasury does not want to see. In order to keep consumer behavior the same, Treasury needs to reinflate that bubble. But doing so just sets us up for another crash.
General consumer financial health would be helped by a shift to greater savings. But any shift will cause a short term contraction in consumer spending, which will mean economic pain for a while. This is a bitter pill to swallow. But it might not be as bad as the alternative, namely the economic effects of consumers becoming so overleveraged that we see massive defaults on all sorts of debts.
Levitin's analysis is grim. Is there an alternative? How about some tried-and-true economic stimulus of the sort that doesn't necessarily encourage consumers to take on more debt, but creates jobs by pumping money into national infrastructure? A new New Deal, as it were.
On Monday, Barack Obama proposed a wish list of initiatives aimed at addressing short-term pain that his advisors pegged at costing about $175 billion. But today, according to the Wall Street Journal, Senate and House Democrats are considering a much more aggressive $300 billion plan.
House Speaker Nancy Pelosi is mulling recommendations from several economists that Congress act on an economic-recovery package that would cost taxpayers $300 billion, according to congressional aides, equivalent to about 2 percent of the country's gross domestic product.
The California Democrat envisions a bill that would include new spending on highways and bridges, extended benefits to unemployed workers, aid to cash-strapped states and a tax cut, congressional aides said.
The chances for such a plan depend on two events. The results of the upcoming election, and the ongoing state of the economy. If Democrats win by a landslide in three weeks, and the data from the real economy continues to indicate worsening conditions, we are going to see congressional action to pump dollars into Main Street that may match what is currently headed to Wall Street. That, in a very real sense, is what voters will be deciding in 20 days. And if Democrats do pull off a significant stimulus plan that creates real jobs and redistributes wealth, we may end up with some new nominees for "national hero."