Like many others across the political spectrum, I’ve been increasingly frustrated with the refusal of the Obama Administration and Treasury Secretary Timothy Geithner to bite the bullet and nationalize the large, troubled banks at the core of our economic crisis. While the many arguments for and against nationalization have been hammered out many times over, I don’t think any of them really get at Obama’s reticence to go that route.
The real reason President Obama will not nationalize the banks is his belief that the larger economy will recover – with his stimulus playing an important role – and will pull the banks out of insolvency. In other words, the banks led the economy into the abyss but the economy as a whole will rescue the banks.
This is a misplaced assumption and, as Paul Krugman argued today, will actually make recovery much harder.
Here’s the problem: a working economy cannot function without sound banks. And we still refuse to reckon with the toxic sludge on the asset side of the bank balance sheets. In fact, there is arguably a lot more trouble coming, as credit default swap exposure at the top five banks threatens to bring the whole system down.
As long as these banks’ assets don’t perform, they will not lend. But they will not sell off the bad assets unless somebody will buy them at a reasonable market price. The government has tried futilely time and again to price these assets in a way that prevents the banks from insolvency while not exposing the taxpayers to too much risk. This is why so many people call for nationalization – these banks simply cannot function in the state they are in. And until they are completely wiped clean of their toxic junk, they will continue as zombies.
Japan made this exact same strategic error in the 1990s. Japanese banks lost billions when the Nikkei imploded in 1990. Instead of forcing the banks to write down these losses, the Japanese government focused on stimulus to get people to spend again. But the banks would not lend and the economy cratered along.
Until President Obama and Secretary Geithner realize that radical action on the banks is necessary before any sustainable recovery can take place, we will continue the spiral downward.