Sorting through the mess

Like most folks, I don’t completely understand the financial crisis our nation is in. But, my lack of full comprehension doesn’t make the questions less compelling. No matter what you call it – a fiscal disaster, a banking crisis, a liquidity issue, or a banking bailout, the questions remain.

These days it seems like the solution is to “purge bad assets that are paralyzing the financial system“. Why is that? What is it about those assets that make them so toxic? Can the banks sell them, much as they bought them in the first place? Sure they are risky, but there’s always an investor willing to take that gamble providing the payoff is sufficient. Instead, the banks want our government to overpay for the loans, right?

As I see it, the plan is to establish a government fund (call it a bank if you like, though it is nothing like anything you’d recognize as a bank) to buy up all the bad investments and loans. It’s those bad calls that are causing banks to be losing money. But, isn’t that what banks are supposed to be best at (and far better than the government’s ability to pick winners and losers) – to judge the loanworthiness of a particular project and to calculate the reserves needed to cover the likely outcome of those loans? Why, then, when they got it wrong do they expect us, the taxpayers, to take responsibility for their bad calls?

Why are banks any different from any other entrepreneurial enterprise that takes a risk, backs their judgment, and goes into business the most efficient way they know how in order to provide the goods and services we demand. Because let us not forget that customers are still wanting to give banks money and that someone else is out there wanting to borrow that same money back. We are saving more than ever before (creating liquidity, right?) and we’re still taking out car loads, credit-card debt and refinancing our homes. We may not be doing that at quite the same rate as we once did, but today’s levels aren’t that far different from what they were five years ago. So, if banks were profitable five years ago, they should be able to profitable today. Lots of smaller banks and credit unions prove that as they are facing a good year of profits they can plow back into reserves, net worth, and available capital.

The smart folks at the Treasury, the Fed, and the Federal Deposit Insurance Corporation are worried that the only people left to invest in bailing out the banks is the government. Lender of last resort, right? But, don’t the big investment companies see the same systemic hazard that the regulators see? That is, don’t they see that a frozen market for capital is going to be their worst nightmare? If investors don’t bailout the banks, then those same investors are going to be a whole world of hurt. Maybe it is time for them to step up and take responsibility for the health of the financial system? After all they probably did as much, if not more, to create the mess in the first place.

Is the government going to pick winners and losers? Will the administration be deciding which companies survive (Bank of America, the new owner of Merrill Lynch) and which fail (the late Lehman Brothers)? Me, I don’t think they’re doing a very good job of it. Instead of rewarding the conservative, well capitalized regional banks and credit unions, it seems they are rewarding the aggressive, merger-hungry, behemoth banks.

Even if that is a strategy, which of course it isn’t, then it’s not being consistently applied. On the one hand we are giving Bank of America $20 billion to complete the purchase of Merrill Lynch investment company at the same time we are giving Citibank $10 billion to sell of its Smith Barney brokerage. Given that the government is now part owner of both B. of A. and of Citi, then we either want to own a bunch of investment gurus or we don’t. Or is there something about Merrill Lynch (which has lost $39.1 billion in the last year and a half) that makes it such a better deal than Smith Barney?

I’m beginning to see why the government makes such a terrible investor on our behalf. The Congressional Budget Office estimated that taxpayers could lose $64 billion on investments made just last year under the first third of the $700 billion financial rescue package we know as TARP. Maybe we should just leave government to do what government does best … spend money, not invest it!

No, none of this makes sense to me. And I think that that may be part of the problem – no-one completely knows what is going on. The banks won’t own up to how much they stand to lose on their bad investments. The economists keep changing their predictions, as they are want to do. And the politicians are afraid to admit that they don’t really know what they are doing, just making ad-hoc decisions as they bumble along.

It is the last group, our politicians, that we can hold accountable. The public needs to have faith in their elected officials, and so we deserve answers to our questions. We need to demand that the decision makers fully understand the consequences of their actions. Otherwise, we’ll be letting them off the hook. And when things get worse, we would only have ourselves to blame. Hmm, somehow I think it’s going to get messier!