Stressing the financial sector

Obviously this economic meltdown of the last couple of years is complex. But if pressed to give a one-sentence answer, I would say this:

For almost thirty years the financial sector got whatever it wanted.

Certain conditions had to be place to make this possible:

  • the widely held idea that markets and business people can do no wrong (and government can do no right)
  • massive amounts of dollars made available by China’s willingness to lend us back the money we sent to them and by Federal Reserve policy
  • a system of campaign finance that allows moneyed interests to dominate politics
  • the willingness of the American households to take on debt

In the end, all of these factors (and many others, of course) came together to empower financial players, ultimately at a multi-trillion-dollar cost to all of us.

To help make my point, I would contrast the treatment of the financial sector to the auto sector. The American car companies have been the other main recipient of government bailouts. But Chrysler has already been sent into bankruptcy, and GM could soon follow. Auto executives have been canned. Auto company workers with valid contracts are being forced to renegotiate and cut back. None of this is true of the financial services sector, especially the big banks.

And contrast what happened before the big meltdown. The federal government fashioned all sorts of policies that the financial sector wanted, from the non-regulation of derivatives to the creation of financial “supermarkets.” As for the auto industry, it never seemed to get what it was ultimately looking for. I covered the auto industry for several years, and I heard auto company and auto union executives call for China and Japan to allow their currencies to strengthen against the dollar. I heard union executives call for an “industrial policy” in the U.S. Everyone knew that health care was dragging the companies down. But I’m pretty sure that auto executives and union leaders also knew they were shouting into the wind. The federal government was simply not going to take action on any of these items. U.S. auto companies and unions simply did not get whatever they wanted (the one exception being the repeated defeat of increased CAFE standards).

Which brings me the current state of the economic meltdown. We do have some slightly encouraging numbers today on employment. Things are still getting worse, just at slower rate.

But the saddest and most frustrating thing about the government’s approach so far (by both the Bush and Obama administrations) is that they continue to give the financial services sector whatever it wants. There’s very little, if any, pushback. And very soon the window for reform will close, as the “banksters” shore up their powerbase again. After surveying the range of opinion out there, I find myself agreeing most closely with the views of Simon Johnson and James Kwak. You can find a good summary of their viewpoint here.

And you can read through some of today’s coverage of the results of the stress tests to find further confirmation that the banks are really in the driver’s seat with the government, even though they would all be out of business if it wasn’t for you and me bailing them out.

Here’s one example:

Some major banks managed to wrest concessions from the government in closed-door negotiations over their “stress tests” that helped them put the best face on their results, financial analysts, industry officials and sources said.

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The banks were intent on sending a message that they were strong enough to weather the economic storm and didn’t need additional capital infusions from the government that could all but nationalize their franchises.

Another sample:

Federal officials have repeatedly vowed to support the 19 banks, which essentially have been labeled too big to fail. Those reassurances have propelled the companies’ shares to their highest levels in months. The White House, Treasury Department and Fed hope that by restoring confidence in the industry, private investors will help troubled banks shore up their finances, eliminating the need for taxpayer-financed rescues.

And maybe most telling, from the same article as above:

A number of analysts pointed out that shares in the 19 stress-tested banks now carry more upside potential than downside risk, if only because the government said in March it would allow none of the 19 firms to fail.

With that assurance in hand, said Brad Hintz, an analyst at Sanford C. Bernstein, the only risk facing bank-stock investors “is dilution risk” — the worry that a firm will need to raise new common equity, which hurts existing shareholders.

Investors “love to have a one-sided bet, and that’s the bet on the financial institutions,” Mr. Hintz said.

Which squares with what a lot of the critics of the financial sector bailout have been saying – heads the financial services folks win; tails we as taxpayers lose.

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