[DEBATE] : Stressing the Positive By PAUL KRUGMAN

[Riaz K Tayob]

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 
be ?reassuring.?

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 
the risks.

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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