Chairs on the Titanic

The stimulus can only work with healthy banks. President Obama needs a better plan.

On Tuesday President Barack Obama signed the American Recovery and Reinvestment Act in Denver. So it begins. The $787 billion stimulus was sold as a necessary step toward economic recovery, and while the truth will eventually bear itself out, he is likely right (though the Buy America provisions will bring nothing but harm). Yet the real economy, the target of the stimulus, is not the key to recovery. No, the financial system still is in the doldrums. Without fixing it, the stimulus will prove impotent. On Feb. 10, Treasury Secretary Timothy Geithner outlined his plans for doing what the previous Troubled Assets Relief Program (TARP) was unable to do âÄî fix Wall Street. Many were disappointed by its vagueness. Without detail, many wondered if ObamaâÄôs team had a plan at all. On the same day Obama signed the stimulus, it became known that Geithner had decided to scrap the plan that had been in the works. It was too complex and, at $1 trillion, too expensive. It was abandoned a week before he gave his initial speech. The lack of a real alternative did nothing to help confidence. The original plan was modeled off of a rescue Sweden conducted after its own banking crisis in the early 1990s. The government had separated troubled banks into âÄúgood banksâÄù and âÄúbad banks,âÄù thus isolating the trouble and focusing on restructuring. That it did not pan out in the United States is not surprising. The Swedish banking system was much less complex, lacking a significant shadow banking system. It also was predominantly owned by the Wallenberg family, who indirectly control about a third of Swedish GDP, lowering the number of actors involved in facilitating a rescue. But the Swedish example only goes so far. Apart from taking banking action, it also devalued its currency by 30 percent, allowing exports to grow the economy. Given international currency dynamics, the U.S. has no such option. Another more common comparison with the current crisis is that of Japan in the late 1980s. Japan itself had an enormous property bust that thrust the country into a period of stagnation that only in 2002 recovered. Part of the problem was that Japan tried to stimulate the economy without fixing the zombie banking system. In fact, only a cultural taboo against bankruptcy prevented the entire economy from imploding. Such an experience should teach a lesson for the current administration. It is very easy for writers to sit and criticize those who actually have to make policy. But the news regarding decision-making process about the financial system rescue is discomforting. Paul Volcker, a former chairman of the Federal Reserve, has been marginalized. He is said to favor a more humble banking system, with tighter regulation in the future and greater bank losses now. Such news leaves Geithner looking much the same as former Treasury Secretary Henry Paulson âÄî as victims of Wall Street âÄúregulatory cognitive capture.âÄù The rescue of the financial system was ultimately necessary. The complex interconnectivity demanded it, or the majority of the nation, not just silly investors, would lose savings. Pensions everywhere already took a hit. But as increasing news of bonuses and other Wall Street sybaritism continues to emerge, there is nothing keeping the public from seeing the final financial rescue as nothing more than Russian-style corporatism at its best. Whether it is true, the court of public opinion relies on appearances as much as facts. At some point, economic recovery needs to become about technical challenge as much as ideology. Americans are not fond of the government being deeply involved in the economy. But if bankers and investors cannot be persuaded to take the losses needed in return for receiving government money, then nationalization is the best move. It might stink like socialism, but that might be the only way to rebuild American capitalism. St. JamesâÄô Street welcomes comments at [email protected]