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Robert Kuttner

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

In the past two weeks, political support for the Tim Geithner/Larry Summers approach to solving the banking crisis has been unraveling in Congress, with blistering criticism from legislators of both parties.

The financial danger is that the Treasury will burn through the money approved by Congress without fixing the system. The political danger is that Republicans will posture as the populists, expressing faux-indignation that so much taxpayer money has gone to Wall Street. The overarching risk to Obama’s presidency is that the plan won’t work, and his political capital will evaporate along with the financial capital.

There is a whole other path to repairing the banking system, and a whole other set of experts, equally brilliant and better in touch with financial realities. But their unfiltered views are not reaching the president. This loyal opposition, of which more shortly, is not limited to lefties; it spans the ideological spectrum.

Though the details are numbingly technical (and deliberately mystified both by the investment bankers and their allies at the Treasury), the basics of what’s wrong with the banking system and how to fix it are, at bottom, very simple.

After all, what do banks do? They take in deposits and they put out loans and make other investments.

In the past decade, far too many of the banks’ investments were far too speculative. They lost vast sums, which now exceed the value of their capital. In plain English, they are insolvent.

In a situation like this, a busted banking system can push the whole economy into prolonged depression. We are right on the edge of that condition, and there is little time to lose.

As the president of the Federal Reserve Bank of Kansas City, Thomas Hoenig, explained March 6 in a brilliant speech (PDF) that is being widely circulated on Capitol Hill, “Too Big Has Failed,” to save the banking system we need a public corporation like the Reconstruction Finance Corporation of the 1930s, which at one point held about one-third of all U.S. bank stock, and by the time it wrapped up its affairs it did not cost taxpayers a penny.

A modern RFC would be given the technical competence and manpower to audit just how bad things are. It needs to determine how far underwater is each of the large banks. (The top four hold about 55 percent of all deposits; fix them and you fix the system.)

The public corporation, according to Hoenig, would need to decide which banks to take into receivership, which ones have competent management teams, and which managers need to go.

Once the size of the hole in bank capital is determined — and it will be on the scale of two trillion dollars — the government needs to decide who eats the loss. How much do the taxpayers put in, and how much do the bondholders have to sacrifice?

Owners of bank stocks are not really relevant. They have already lost upwards of 95 percent of their investments. When a bank is taken into receivership, they will lose the rest. But it’s no big deal for the system. Trying to use public money to pump up the value of bank stocks — Geithner’s approach — has it backwards.

Finally, when the banks are restored to solvency, they need to be returned to private ownership.

Hoenig is not exactly a Bolshevik, but he is embracing Roosevelt and the President’s men are not. A well-staffed government corporation, which would take insolvent banks into receivership, is the most effective approach because it gets the job done swiftly and transparently, and with the least unnecessary government subsidy of market middlemen.

Last week, at a hearing of the Joint Economic Committee, Alex Pollock of the conservative American Enterprise Institute commended this strategy, and the Committee’s ranking Republican, Sen. Sam Brownback of Kansas embraced it. For a quick tutorial, the video of the hearing is must-watching.

But the Geithner/Summers strategy is the complete opposite. Geithner hopes to enlist hedge funds and private equity companies to purchase bonds from banks, using loans and loan guarantees from the Treasury and the Federal Reserve, and thereby restart the very system that failed.

This approach gives far too much power and taxpayer subsidy to the least transparent and least regulated parts of the financial system. On Saturday, the Wall Street Journal reported that the announcement of the details of the plan had to be delayed yet again, because two of the biggest firms wanted even sweeter terms before they came to the table.

This latest Geithner scheme to restart the doomsday machine of securitization for newly issued bonds is the fifth do-over since Paulson embarked on this path last October. Geithner’s scheme sidesteps the core problem that stymied Paulson — what about the pre-existing bonds that are clogging bank balance sheets? This huge hole in bank assets is a far bigger challenge than re-starting the engine of new lending, which never entirely quit.

The Geithner/Summers approach is complex, slow, ad hoc, non-transparent, and far too Wall Street oriented. Only now is Geithner getting around to initiating proper audit of the zombie banks he is aiding, under the euphemism, “stress tests.”

As an indication of just how closely Geithner and company are acting on Wall Street’s behalf, consider this tidbit, whose significance the media largely missed: Friday’s Washington Post reported that a man named H. Rodgin Cohen, under consideration for Deputy Treasury Secretary, had become the latest proposed senior appointee to withdraw from consideration. The Post treated the story as part of the continuing saga of unfilled sub-cabinet jobs.

But who is “Rodge” Cohen? Astoundingly, he is a senior lawyer from the firm of Sullivan and Cromwell, and the man who has been negotiating with Geithner on behalf of the large Wall Street banks!

What the hell, if you’re going to act mainly in the interests of the banks, why not bring just their people right into government? The story didn’t give details, but only mentioned that “an issue” had emerged during the vetting process. We can only imagine what kinds of conflict of interest problems the vetting team unearthed.

If you ask the question, how can we get America’s banking system restored to health, the Geithner/Summers approach makes absolutely no sense. But if you ask a different question, it makes perfect sense: how can we pump up the share price of outfits like Citi and Goldman, while we pump in taxpayer and Federal Reserve money and hope for a miracle.

Unfortunately, a miracle is just what it would take for this approach to work.

Unlike Roosevelt’s RFC, the Treasury lacks any institutional capability to do the job properly. As a consequence, it shovels out money first, does audits later, oscillates wildly between being hands off and micro-managing, and tries to wring out purely symbolic sacrifices like making Citi give back its proposed new $43 million executive jet.

On Sunday morning, the talk shows were dominated by the revelation that AIG — on the hook to taxpayers for $175 billion — was paying out bonuses to the very unit in London that caused the catastrophe. The newspaper stories suggested that news of this latest outrage originated with a preemptive leak from the administration.

Larry Summers solemnly declared on the Sunday talk shows that these bonuses were appalling, but that America is a nation of laws where “a contract is a contract.” That’s malarkey. The UAW has been forced to renegotiate contracts as part of the auto bailout.

Summers credited Secretary Geithner for reducing the original proposed bonuses, but if Geithner has the leverage to achieve that reduction, he has the leverage to reduce the bonuses to zero. The government owns 80 percent of AIG.

But the outrage over the AIG bonuses is a sideshow. The larger problem, both financially and politically, is the entire strategy for rescuing the banks.

It would be hard to imagine two administrations seemingly more opposite than the Bush and the Obama presidencies. Yet Geithner’s approach is essentially a continuation of the failed strategy of Bush Treasury Secretary Henry Paulson, Geithner’s former close colleague in Geithner’s prior role as president of the New York Fed.

In defending the AIG bonuses, CEO Edward Liddy actually said that you had to pay bonuses to attract and keep “the best and brightest talent,” in this case the very people who are costing America’s taxpayers $175 billion and counting. Far from receiving bonuses, these people deserve to share a cell with Bernie Madoff.

By the same token, Larry Summers and Tim Geithner are not the only smart people about finance. If President Obama wants a second opinion, he could begin with Paul Volcker, nominally chairman of Obama’s own “Economic Recovery Advisory Board,” which so far is mainly window-dressing. According to my sources, Summers and Geithner seldom talk to Volcker because they don’t like Volcker’s criticisms of their plan.

The president could also consult with several people in the Federal Reserve System who have a different view, and also the FDIC leadership, and the Congressional Oversight Panel that was created by Congress as the precondition for appropriating the TARP money. The panel has the statutory right to get documents from the Treasury. But under Geithner as under Paulson before him, Treasury has been stonewalling. Legislators of both parties are increasingly viewing Geithner as part of the problem.

As the administration continues its coziness with Wall Street and the approach fails to bring zombie banks back to life, populist anger passes to both the Republicans and to media tribunes such as Lou Dobbs. This brand of populism is one part anti-Wall Street, but two parts anti-government and anti-immigrant. It has no strategic coherence as a recovery plan.

The alternative to Lou Dobbs’ brand of populism is of course Franklin Roosevelt’s. But something is really off when Sen. Sam Brownback, the AEI, and the Kansas City Federal Reserve Bank start sounding more like Roosevelt than Barack Obama’s treasury secretary does.

Obama needs to get a second opinion, firsthand.

Robert Kuttner is co-editor of The American Prospect and a senior fellow at Demos. His latest book is “Obama’s Challenge: America’s Economic Crisis and the Power of a Transformative Presidency.”

Leo W. Gerard

By Leo W. Gerard
International President

It would be easy in these troubled times to shrink from campaign promises, to cower from the greatness that might have been, to claim that the beast of the Bush recession had devoured the nation’s potential to achieve great goals.

President Barack Obama chose instead to arrive at his first address to a joint session of Congress prepared to restore America’s hope for lofty causes. In addition, during those 52 minutes of inspiration, President Obama renewed his commitment to work for the benefit of working people, calling for a legislative focus this year on three areas crucial to them: education, energy and health care.

“We are a nation that has seen promise amid peril, and claimed opportunity from ordeal. Now we must be that nation again,” the president said. Yes. Yes we can.

“The weight of this crisis will not determine the destiny of this nation,” he said. “The answers to our problems don’t lie beyond our reach. They exist in our laboratories and universities, in our fields and our factories, in the imaginations of our entrepreneurs and the pride of the hardest-working people on Earth.” Notice that the president didn’t mention in this group those vaunted Wall Street financial brainiacks. He did, however, specify working people, blue collars in fields and factories and white collars in labs and universities.

This next bit is crucial. President Obama said he believes government has a responsibility to act during this economic crisis to help resolve it:

“I reject the view that says our problems will simply take care of themselves; that says government has no role in laying the foundation for our common prosperity.

For history tells a different story. History reminds us that at every moment of economic upheaval and transformation, this nation has responded with bold action and big ideas. In the midst of civil war, we laid railroad tracks from one coast to another that spurred commerce and industry. From the turmoil of the Industrial Revolution came a system of public high schools that prepared our citizens for a new age. In the wake of war and depression, the GI Bill sent a generation to college and created the largest middle-class in history. And a twilight struggle for freedom led to a nation of highways, an American on the moon, and an explosion of technology that still shapes our world.

In each case, government didn’t supplant private enterprise; it catalyzed private enterprise. It created the conditions for thousands of entrepreneurs and new businesses to adapt and to thrive.”

That puts him in conflict with Republicans who want to sit idly by or believe government should commit more of the shameful failures that got the U.S. into this mess – cutting taxes – particularly for businesses. That is exactly what Louisiana Gov. Bobby Jindal offered as a solution when he rebutted President Obama’s speech for the Republicans afterwards.

Then he went on to try to squirm out of his own party’s responsibility for the current budget deficit – caused in large part by the massive tax cuts the Republican Congress and Republican President bestowed on the rich.  Here’s what Jindal said: “In recent years, these distinctions in philosophy became less clear – because our party got away from its principles. You elected Republicans to champion limited government, fiscal discipline, and personal responsibility. Instead, Republicans went along with earmarks and big government spending in Washington. Republicans lost your trust – and rightly so.” Really? Republicans, who controlled Congress, “went along with” earmarks? Even now they refuse to accept “personal responsibility!”

Among President Obama’s promises in his speech, by contrast, was that he would reverse those Republican tax cuts for the rich. In a pre-emptive strike, he pointed out that only those earning more than a quarter million dollars a year would return to tax rates they had paid before Bush took office. Jindal suggested the Democratic programs would “saddle future generations with debt.” But, again, he failed to mention the debt created by the Republican tax cut for the rich.

President Obama doesn’t accept Jindal’s premise at all, however. He believes that government can be used to prod the economy to grow. He said, “The only way to fully restore America’s economic strength is to make the long-term investments that will lead to new jobs, new industries, and a renewed ability to compete with the rest of the world. The only way this century will be another American century is if we confront at last the price of our dependence on oil and the high cost of health care; the schools that aren’t preparing our children and the mountain of debt they stand to inherit.  That is our responsibility.”

He said the process begins with energy and that the country that harnesses the power of clean, renewable energy will lead this century. Yet, he said, China has moved ahead of the U.S. to make its economy energy efficient. The U.S. invented solar technology, “but we’ve fallen behind countries like Germany and Japan in producing it.  New plug-in hybrids roll off our assembly lines, but they will run on batteries made in Korea. Well I do not accept a future where the jobs and industries of tomorrow take root beyond our borders – and I know you don’t either.  It is time for America to lead again.”

What’s significant about this is not just that he is seeking leadership in a crucial area, but that he wants factories and workers in the U.S. to make the parts – not import them. Similarly, he promised to remove the tax credit given multinationals that move their manufacturing facilities overseas and to ensure a re-imagined and competitive auto manufacturing industry in America. This president understands the value of that made in America label.

It’s telling who President Obama chose to bring to the assembly and single out first for praise. It was Leonard Abess, a bank president from Miami, who gave his $60 million bonus to his 471 workers. Mr. Abess said he didn’t feel right keeping it himself. This stands in stark contrast to those Wall Street financers who walked away with millions in bonuses – never looking back — after taxpayers had bailed out their failed banks. Obama said that kind of abuse would end in his administration.

Like Abess, Obama clearly appreciates workers. Yes, he does.