EconomistMom.com

Having the federal government “rescue” or “stimulate” the U.S. economy isn’t an easy thing to do.  In Friday’s Washington Post, Steven Pearlstein writes of “Hank Paulson’s $125 billion mistake.”  That would be referring to the $125 billion in new capital provided by Treasury to the nine biggest banks, in what was billed as ”partial nationalization.”  (Hard to believe that was just a couple weeks ago.)  My view at the time was that having the federal government hold some sort of equity stake in these banks was at least better than having no stake at all and holding only “bad paper” (sometimes referred to, oxymoronically, as ”toxic assets”).  But Steven explains why some who advocated the move now think it’s not going so well:

Now, many of the same people are shocked — shocked! — to discover that the banks aren’t using the money to make new loans to households and businesses, as they had assumed, but are using it to maintain dividend payments to shareholders, pay this year’s bonuses to executives and traders, or squirrel it away for future acquisitions.

I hate to say it, but I told you so. Sprinkling money around a highly fragmented banking system when markets were panicked and everyone was scrambling to reduce leverage was always akin to shoveling sand against the tide…

[M]aking modest investments in dozens of banks, whether they needed it or not, produces little for the public beyond the small profit for the Treasury. What it does do, however, is open the door for every politician and populist to second-guess every decision and expenditure the banks make, based on the false assumption that everything they do is with “our money.”

In other words, it is still just partial nationalization, and market prices and private profit-seeking are still the major forces at work.  Just because the government is effectively a shareholder now, doesn’t mean the government can actually control how these banks choose to run their businesses. 

Then Steven goes on in a way that leads my mind to wander past the banks and the government’s $125 billion “mistake”…

[I]n trying to persuade banks that don’t need the money to take it, the Treasury has wound up offering everyone the same sweetheart deal that gives the government little say in how the money is used or how the banks are run. That’s particularly dangerous in the case of weaker banks, which might be tempted to take big risks in the hope of recouping past losses or to divert money to shareholders and executives before the inevitable government takeover.

In the case of some of the stronger banks, however, much of the carping about bonuses and dividends and refusal to lend are a bit overblown…

…and which leads me to wonder:  if we’re worried that the $125 billion “partial nationalization” of the biggest banks could turn out to be a “mistake”–because the government has little control over how the money gets used by the assisted industry–then might this be just the first of many mistakes to come?  Gee, look at that story in the paper right next to the continuation of Steven’s column on page D6, “Government Urged to Help Auto Industry“… and the story in today’s Washington Post about how Michigan voters have been unusually sympathetic to the $700 billion rescue plan, “in large part because voters think the auto industry needs a similar boost.”

Steven seems to think the worries about the lack of new lending are overblown.  He reminds us that the banking industry has not really been nationalized (not fully, and maybe that means not really at all–like a woman can’t be partially or sort of pregnant?), and that what we’re really worrying about here is that some of the money is being saved rather than lent out:

[B]anks like J.P. Morgan, Wells Fargo, State Street and the newly chartered Goldman Sachs remain highly profitable and well-capitalized. It ought to be up to them to decide whether to use those profits to add to capital reserves or pay them out in dividends and executive bonuses. We might not like their choices, or their values, but this is still a market economy, and these are still shareholder-owned companies. The industry hasn’t been nationalized just yet.

It is also useful to remember that the way banks make money is to lend it out, not hold it in the vault or invest it in low-yielding Treasury bonds. Hoarding is not generally a winning strategy for maximizing share prices or executive bonuses. It is also useful to remember what got us into this mess in the first place. If banks are using their new capital to reduce their own leverage, or are more cautious about whom they lend to, that’s probably a good thing.

Yes, there’s what I’ve talked about a lot before–the really tricky thing about immediately “stimulating” the economy (boosting consumption) given what brought us to the more fundamental and longer-lasting “mess” in the economy as a whole (too much consumption/too little saving).  It’s a very general challenge in the current economic climate:  how can we ”rescue” and “stimulate” the economy without encouraging the “living beyond our means” mentality that is so harmful to the longer-term health of our economy?  (The Concord Coalition suggested some ways to think about it in our recent issue brief.)  It’s interesting that a Business section story in today’s Washington Post on stimulus ideas highlights the contrary short-term versus long-term prescriptions, in listing the “downsides” of many of the stimulus proposals as they might decrease national saving!  (…which is actually what we want it to do, at least in the short run.)

Then Steven wraps up his column as if he’s known all along where my thinking was going, especially with my recent preoccupation with the auto industry:

Perhaps the worst part of this misguided effort to recapitalize the banking system is that it has prompted other industries to line up for similar sweetheart deals. Automakers, insurers, auto finance companies and local governments are already besieging the Treasury, and you can be sure that others are refining their pitch. One can only hope that the terms of future deals will be sufficiently onerous that going to the Treasury will be become a last resort, not a first instinct, for industries in trouble.

That’s the basic (and tough) challenge facing policymakers (when they come back for the lame duck session after the election): how to get federal support out there in our economy where it will make a difference and where it will turn out to have been “worth it” to current and future taxpayers.