Letting Them Fail

by digby

Dean Baker makes the case for nationalization in terms I think everyone can understand, by framing it in the context of a post-Lehman world. The moral hazard of letting these institutions, and more importantly, these executives, continue to believe that they are beyond the reach of failure or sanction get greater by the day. (I’m not sure that “shame” is something that actually means much among the ruling class, so there has to be something more.)

He writes:

But now we have had six months to adjust. The Fed and Treasury are now guaranteeing deposits in money-market mutual funds. The Federal Deposit Insurance Corporation doubled the size of the bank accounts it guarantees, and non-interest-bearing accounts of any size are guaranteed. In addition, the Fed is now lending hundreds of billions of dollars directly to non-financial corporations, establishing a channel of funding that goes outside the banking system. These and other measures have restored some measure of stability to the financial system. Now that we have these measures in place, is it still true that we can’t subject Citigroup, Bank of America or Goldman Sachs to a managed bankruptcy (aka “nationalisation”) without the world coming to an end? With a managed bankruptcy, all the insured deposits would be fully covered. However, the government would only repay bondholders a portion of their investment, depending on how severe the banks’ losses are. By not compensating bondholders in full for their losses, the government could save taxpayers hundreds of billions, perhaps even trillions, of dollars. In addition, a managed bankruptcy would also help to address the problem of moral hazard created by the bailouts thus far. Investors did not pay adequate attention to the health of banks and other large financial institutions like AIG because they assumed that the government would bail them out if things went badly. If the government makes these investors eat some of their losses, maybe they will put more thought into their investment strategies in the future. This could also let some big investors make some of the “sacrifices” for which fiscal conservatives – including some big investors – are so eager.

Exactly. Baker also asks the question I’ve been asking:

The silence of the fiscal conservatives on the vast sums going to the banks is hard to understand. After all, how can someone get so upset about the prospect of $200m being spent to re-sod the National Mall in Washington, but be unconcerned when $160bn – almost 1,000 times as much money – goes out the door to AIG? The sums of money going to bail out the financial industry dwarf the waste and pork that get John McCain and other budget hawks excited. Yet they are strangely calm about the bailout money. In fact, the amount we spent patching the financial system could well be large enough to make the Social Security system fully solvent over its 75-year planning horizon, yet we barely hear a peep from the Peter Peterson Foundation and its merry band of anti-Social Security crusaders.

I think that proves what their real agenda is. If they were really worried about fiscal responsibility they would be using some of their credibility to weigh in on this crisis. They are clearly using disaster capitalist tactics to destroy the safety net, period.
As for the bonus issue that has everyone captivated, Obama just made a political error that I wish he hadn’t made. The press doesn’t understand any of these issues and so they are now fixating on “what did Obama know and when did he know it” and why hasn’t he returned the campaign contributions of AIG mployees. This is the way they see their world and Obama avoided answering the questions when they were put to him a few minutes ago in a brief press avail. You can’t do that. Chris Matthews’ and Andrea Mitchell’s heads are now spinning like Linda Blair’s in the Exorcist and they are in full blown frenzy. It may blow over because of the plethora of news, but it’s the sort of thing to which the DC press corps has a pavlovian response.
And poor Chris Dodd. They threw him under the bus and the dumbest of the cable media vultures are still feeding on his living carcass. It’s political poison for the administration — Obama is already in grave danger of losing solidarity among the Dems. If they feel the administration is willing to sacrifice them on something like this, he’s going to have a very rough go. Democrats aren’t very good at holding together in the best of times. Running scared, they will be unmanageable. I thought Rahm was some sort of political genius who understood all this.

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