[DEBATE] : Stressing the Positive By PAUL KRUGMAN
Riaz K Tayob
riaz.tayob at gmail.com
Fri May 8 09:41:20 BST 2009
Stressing the Positive By PAUL KRUGMAN
Hooray! The banking crisis is over! Let?s party! O.K., maybe not.
In the end, the actual release of the much-hyped bank stress tests on
Thursday came as an anticlimax. Everyone knew more or less what the
results would say: some big players need to raise more capital, but over
all, the kids, I mean the banks, are all right. Even before the results
were announced, Tim Geithner, the Treasury secretary, told us they would
But whether you actually should feel reassured depends on who you are: a
banker, or someone trying to make a living in another profession.
I won?t weigh in on the debate over the quality of the stress tests
themselves, except to repeat what many observers have noted: the
regulators didn?t have the resources to make a really careful assessment
of the banks? assets, and in any case they allowed the banks to bargain
over what the results would say. A rigorous audit it wasn?t.
But focusing on the process can distract from the larger picture. What
we?re really seeing here is a decision on the part of President Obama
and his officials to muddle through the financial crisis, hoping that
the banks can earn their way back to health.
It?s a strategy that might work. After all, right now the banks are
lending at high interest rates, while paying virtually no interest on
their (government-insured) deposits. Given enough time, the banks could
be flush again.
But it?s important to see the strategy for what it is and to understand
Remember, it was the markets, not the government, that in effect
declared the banks undercapitalized. And while market indicators of
distrust in banks, like the interest rates on bank bonds and the prices
of bank credit-default swaps, have fallen somewhat in recent weeks,
they?re still at levels that would have been considered inconceivable
before the crisis.
As a result, the odds are that the financial system won?t function
normally until the crucial players get much stronger financially than
they are now. Yet the Obama administration has decided not to do
anything dramatic to recapitalize the banks.
Can the economy recover even with weak banks? Maybe. Banks won?t be
expanding credit any time soon, but government-backed lenders have
stepped in to fill the gap. The Federal Reserve has expanded its credit
by $1.2 trillion over the past year; Fannie Mae and Freddie Mac have
become the principal sources of mortgage finance. So maybe we can let
the economy fix the banks instead of the other way around.
But there are many things that could go wrong.
It?s not at all clear that credit from the Fed, Fannie and Freddie can
fully substitute for a healthy banking system. If it can?t, the
muddle-through strategy will turn out to be a recipe for a prolonged,
Japanese-style era of high unemployment and weak growth.
Actually, a multiyear period of economic weakness looks likely in any
case. The economy may no longer be plunging, but it?s very hard to see
where a real recovery will come from. And if the economy does stay
depressed for a long time, banks will be in much bigger trouble than the
stress tests ? which looked only two years ahead ? are able to capture.
Finally, given the possibility of bigger losses in the future, the
government?s evident unwillingness either to own banks or let them fail
creates a heads-they-win-tails-we-lose situation. If all goes well, the
bankers will win big. If the current strategy fails, taxpayers will be
forced to pay for another bailout.
But what worries me most about the way policy is going isn?t any of
these things. It?s my sense that the prospects for fundamental financial
reform are fading.
Does anyone remember the case of H. Rodgin Cohen, a prominent New York
lawyer whom The Times has described as a ?Wall Street éminence grise??
He briefly made the news in March when he reportedly withdrew his name
after being considered a top pick for deputy Treasury secretary.
Well, earlier this week, Mr. Cohen told an audience that the future of
Wall Street won?t be very different from its recent past, declaring, ?I
am far from convinced there was something inherently wrong with the
system.? Hey, that little thing about causing the worst global slump
since the Great Depression? Never mind.
Those are frightening words. They suggest that while the Federal Reserve
and the Obama administration continue to insist that they?re committed
to tighter financial regulation and greater oversight, Wall Street
insiders are taking the mildness of bank policy so far as a sign that
they?ll soon be able to go back to playing the same games as before.
So as I said, while bankers may find the results of the stress tests
?reassuring,? the rest of us should be very, very afraid. Copyright 2009
The New York Times Company
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