Republican banking solution: Dangerous nonsense

John McCain and Richard Shelby say "let them fail." Just how bad do they want this depression to get?

Published March 9, 2009 3:24PM (EDT)

In an alternate universe, John McCain would be president of the United States, and Alabama's Richard Shelby would be back as chairman of the Senate Banking, Housing, and Urban Affairs Committee, where he ruled the roost until the midterm elections of 2006.

But if their comments over the weekend on the banking crisis can be taken as an indication of how Republicans would be governing now, the world would be hurtling even faster toward the Second Great Depression.

John McCain, on "Fox News Sunday": "I don't think they've made the hard decision, and that is to let these banks fail."

Richard Shelby, on ABC's "This Week": "I think that they've got to close some big banks. They don't want to do it ... I don't want to nationalize them. I think we need to close them ..."

Ridiculous. We can argue all day about whether or not we should be nationalizing the likes of Citigroup and Bank of America today, or keep striving to engineer some other solution, à la "the bad bank." But to suggest that we do nothing, stand back, and let them go down in flames is simply not a credible strategy. One would have imagined that the global economic disaster caused by letting Lehman Brothers fail would be enough to prove that.

In terms of its deep and myriad interconnections with the global economic system, Citigroup is to Lehman Brothers as a wooly mammoth is to a beagle.

Here is James Kwak's description, at the Baseline Scenario, of what would happen if Citigroup failed, "in such a way that creditors did not get all their money back." (By creditors, Kwak is referring to the holders of bonds issued by Citigroup.)

The first-order concern is that this would have ripple effects that could take down other financial institutions. According to Martin Wolf, bank bonds comprise one quarter of all U.S. investment-grade corporate bonds; losses would be spread far and wide, hitting other banks, pension funds, insurance companies, hedge funds, and so on. If Citigroup did not support its derivatives positions, then institutions that bought credit default swap protection from Citi would face further losses... The fear is that it will be impossible to predict how these losses will be distributed and who else might go down.

The second-order concern is bigger... Once investors figure out that bank debt is not safe, they will refuse to lend to any banks, and we are back in September all over again. Or almost: it is possible that the Federal Reserve's massive efforts to provide liquidity to the banking system will be enough to keep banks functioning. But who wants to take that risk?

Nobody who is actually in power wants to take that risk, because the consequences of being wrong are severe beyond imagining. But McCain and Shelby are not in power, and thus can say whatever they want. Really, the only decent explanation for their irresponsible comments is that they are purposefully attempting to spook the markets by raising the possibility of massive bank failures, just to make the Obama administration look bad.

By Andrew Leonard

Andrew Leonard is a staff writer at Salon. On Twitter, @koxinga21.

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