The U.S. Treasury, at taxpayer expense, is pumping out an initial $124 billion in bailout money to 24 of America's biggest banks, in hope of getting them to start lending again. But many of these banks are so traumatized that they're reluctant to lend.
So why waste the money on them? If the government took over a failed bank outright, instead of throwing money at banks that it can't or won't control, government could do the job properly.
Banks ordinarily lend out money at several multiples of their own capital. They take in deposits and also borrow short-term cash in money markets -- and then lend the money to consumers and businesses. Because they have to keep capital reserves against possible loan losses, when their own capital takes a big hit, their lending implodes.
In this crisis, the banks have lost many hundreds of billions of dollars of capital. Falling stock prices have depressed their capital value even further. The theory was that if government replenished a big chunk of that capital, banks would start lending again.
But apparently you lead a banker to capital, but you can't make him lend. Several banks, most notably Citigroup, have advised Treasury Secretary Henry Paulson that they don't consider business conditions right to do a lot of lending. Instead, they plan on using the money to buy up other banks and to pay shareholders dividends. Paulson behaves as if the government has no leverage, despite having just given Wall Street all this money.
Paulson didn't even ask for the right to have the government get bank stock in exchange for all this taxpayer money, but Congress insisted on giving it to him. Now, however, he is refusing to exercise the rights of ownership -- which is to make policy.
Several outraged members of Congress, led by Speaker Nancy Pelosi, have argued that Paulson should set tougher conditions. For instance, there should be no payment of dividends to shareholders during the period that a bank is taking public money; and no mergers or acquisitions without the consent of government, and no executive bonuses or "golden parachutes."
In fact, the use of taxpayer funds to pay dividends is the bigger outrage. After all, when private shareholders invested in a bank, they accepted the risks of ownership. They get dividends in good years -- but in bad years they take a hit. The government bailout was intended to start credit flowing again, not to finance dividend payments.
But the bankers' lobby and its chief man in Washington, Paulson (temporarily on duty at the Treasury), argue that if government puts strings on its aid, it will scare off private capital. In this view, if government limits dividends, it will be bad for the value of the banks' stock. This is nonsense, because in a year when banks are taking huge losses, they have no business paying dividends under any circumstances.
However, even a number of Democrats have bought the argument. "There's not much we can do other than jawbone," Sen. Chuck Schumer told The Wall Street Journal. Schumer, a close friend of the financial industry, could be Banking Committee Chairman in the next Congress. And within the Obama camp, economists Larry Summers and Laura Tyson are sympathetic to the view that Treasury should not push the bankers too hard, lest stock prices get depressed. However, House Financial Services Chairman Barney Frank plans hearings November 18 aimed at imposing stronger conditions.
Meanwhile, the United Steelworkers union has released an analysis comparing Paulson's recent deals to provide government funds in exchange for stock warrants with a similar deal made by super-investor Warren Buffett when he recently invested $5 billion in Goldman Sachs. Researchers for the Steelworkers calculated that Buffet got between seven and 14 times in share value what Paulson negotiated on behalf of taxpayers.
Paulson was one shrewd deal-maker when he worked on Wall Street as the head of Goldman Sachs. But now that he is at Treasury, he is letting the banks take his supposed client (the American people) to the cleaners. You'd almost think he was still working for the banks.
Under Paulson, government assumes all of the losses -- but feigns impotence when it comes to getting the banks to resume lending. So it would be much better for the government to take over at least one bank outright. Then the government-owned bank, freshly capitalized with new public funds, could resume lending -- and not have to worry about paying dividends, satisfying stock analysts, or manipulating its share price.
Franklin Roosevelt called this strategy "yardstick competition." In key industries, his idea was to have one public institution compete directly against private ones, to test their claims and to lead the way. The FDIC already does this on an interim basis when it takes over failed banks. If the private banking sector can't get credit flowing again, it's better for government to start doing the job directly rather than throwing money at bankers who won't cooperate.