Obama's Dangerous Bank Bailout

Restoring Citi and BofA to greatness shouldn't be the goal.

By HOLMAN W. JENKINS, JR.

Team Obama is wrestling internally over the bank bailout supposedly to be introduced next week. We naturally are on the edge of our seats.

But let's understand something: The taxpayer already stands behind the banking system, and is on the hook for its losses in one sense or another. Moreover, that guarantee has become more and more explicit in recent months -- which is not an unmixed blessing, since such explicitness has tended to create new uncertainty among those stakeholders not specifically included in the safety net.

The main uncertainty lately has been whether the safety net includes bank shareholders as well as depositors and creditors. That uncertainty is why we have crazy gyrations in bank share prices, and yet don't have bank runs. Citigroup's shareholders only account these days for a measly $20 billion, in a bank with liabilities of $2 trillion -- yet market speculation over their fate has seemed to be driving government actions.

Here we see the downside of explicitness. By committing specific sums to given banks, policy makers only ended up inviting new speculation about what happens when those cushions are exhausted by fresh accounting writedowns. And now Team Obama seems about to recapitulate this folly with another round of explicit guarantees.

By current leakage, their plan will consist of explicit government insurance for certain bad assets and explicit purchases of other bad assets to be held by a so-called bad bank. For the months or years, then, that it takes to put the plan into effect, the market will have to speculate anew about how each bank's assets will be valued for bailout purposes.

Yet there is a solution better than trying to finalize a division of losses whose size won't be known for years to come. That solution is time, the healer of all wounds.

Remember, this is not the S&L crisis of the 1980s, when hundreds of small banks were incentivized by poor regulation to try to gamble their way out of self-made holes. Today's problems are concentrated on the balance sheets of the biggest, most visible banks. Little banks are relatively easy to close or force into mergers. Banks that are "too big to fail" aren't too big for government to manhandle in a crisis; it's just that the solution is not the same as for a small bank.

Which raises the question: Why not just leave Citi and BofA's bad assets where they are, albeit with regulators sitting at management's elbow to make sure their losses are being conservatively worked off and no wild gambles on resurrection are being taken? The losses would stay with bank shareholders, even if it took 15 years of cash flow to work them off. There'd be no perplexing muddle over how to value assets for bailout purposes. And because the shareholders' stake (much diminished) would remain intact, there'd be every incentive to manage the assets well while minimizing the risk of a bottomless mess like government has made of AIG.

But now we come to the most dangerous assumption underlying the rumored Obama approach -- the idea that we need something called Citi and BofA quickly liberated from their past mistakes so they can go back to serving as the engines of the economy.

They aren't the engines of the economy -- we have a vast and diversified financial sector. Today's real problem is a shortage of reliable borrowers, especially given the uncertainty about house prices. Washington's misguided goal, if you listen closely, seems to be turning these giant banks into public utilities to "jumpstart lending" under political duress. That is, shoveling money at an overleveraged private sector in hopes of stopping the economy from shrinking and markets from clearing.

We should keep in mind that Japan's "lost decade" wasn't so much an accident as a deliberate decision to avoid a rash of foreclosures and bankruptcies and layoffs that might disturb a somnolent "harmony." Whether or not that was the right choice for the Japanese, the U.S. is a different country, and would probably react differently, and not well, to a prolonged government-sponsored stagnation. Yet that's where the Obama bailout may be leading us.