Let’s try a thought experiment. I say: “The financial crisis is over.” You respond: “You can’t kid us; this is your idea of an April Fool’s joke.” Actually, it isn’t; it’s an attempt to lay out some reasons why the worst might — only might — be behind us.
Yes, there will be more Gucci loafers to drop, more pain for banks, homeowners and taxpayers. So I am not saying that we can sit back and wait for the Dow to soar, house prices to rise and bankers to beam all in the next few months. But it is worth considering the possibility that the contours of the solution to the problems in financial markets have now been sketched out, that it is only a matter of time until the credit crunch is history.
Then, we can start worrying about inflation and the ability of more closely regulated financial markets to continue to produce the innovations that have in the past powered American capitalism.
When Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke agreed to take almost $30 billion of Bear Stearns’ paper onto the Fed’s balance sheet, putting taxpayers at risk if that paper proves to be of little value, they did in 10 days what it took Franklin Roosevelt 100 days to do. They changed the nature of free-market, finance capitalism.
“Too big to fail” — the doctrine that led to the 1984 bailout of bond holders of Continental Illinois, the seventh-largest bank in America — has been supplemented with “too interconnected to fail.” Commercial banks can’t be allowed to fail because they are too big, and investment banks can’t be allowed to fail because heaven only knows how many other financial institutions they will bring down with them.
When taxpayer money is put on the table, so too is a new regulatory regime. Like “love and marriage” and “a horse and carriage” in the great Sinatra tune, when it comes to government cash and regulation, “You can’t have one without the other.” So we are witnessing nothing less than the end of a decades-long movement to deregulate financial institutions, and of the idea that depository institutions (commercial and savings bank) need close supervision but investment banks don’t.
Now they do, lest they use the knowledge that they will not be allowed to fail to make wildly risky loans and investments. It’s called “moral hazard” — and the hazard light is flashing red.
Hillary Clinton and Barack Obama want the investment banks regulated. More important, so does the chairman of the House Financial Services Committee, Barney Frank. Even Hank Paulson has conceded that access to taxpayers’ funds “should involve the same type of regulation and supervision” as applies to commercial banks.
So before this is over, the macho investment bankers who wanted as little to do with Washington as possible will be required by regulators to raise more capital in the market, causing dilution of holders of existing shares. And the regulators will insist that investment banks cut their dividends, something they don’t want to do, but will find is part of the price they must pay for access to taxpayer money. But, hey, when the man from the government shows up to help you, he generally has a few conditions that you might find distasteful.
The battle lines now being drawn are between supporters of the 200-page Treasury blueprint for reform, released over the weekend, and Democrats who want to go further. Paulson, laying out a study that was prepared before the current difficulties, would consolidate powers now spread across many agencies and give the Fed broad new supervisory authority but not much regulatory power. Frank finds it encouraging that “the former head of Goldman Sachs [is] acknowledging that regulation is good for financial markets and it’s not going to kill them,” but wants to go further and treat investment banks the same way depository institutions are now treated.
The only question now is whether the coming revolution, whatever its final shape, will improve the functioning of financial markets or merely add red tape and costs, and discourage the innovation that has added so much to keeping capital costs low. Answers are not yet available.
Meanwhile, add together low interest rates, Fed moves to pump liquidity into the market and the coming fiscal stimulus, and it becomes plausible — not certain, but plausible — that talk of crunchless days ahead is more than an April Fool’s joke. So, too, is talk of the dangers of nationalizing all of this debt, but that’s a worry for another column.
Examiner columnist Irwin Stelzer is a senior fellow and director of The Hudson’s Institute’s Center for Economic Policy.
