Geithner's Folly: The Bank Rescue Plan Is a Disaster in the Making

By Brad Reed, AlterNet. Posted February 11, 2009.

Baker adds that the government takeover of the banks isn't permanent: rather, the government removes the bad assets from the bank before reorganizing it and then selling it to the private sector as a healthy bank.

"The normal way to deal with a bad bank is to wipe out the shareholders, fire most of the executives, reorganize it, soak up the assets that are nonperforming and sell them over time," says Stirling Newberry, an economics writer at the Agonist. The end goal of any bank reorganization plan, he notes, should be to eventually "merge the bank with a healthier bank."

Nouriel Roubini, the New York University economist who correctly predicted the current financial crisis long before many economists saw it as a serious threat, recently endorsed nationalizing banks while responding to reader questions over at the Financial Times' Web site.

"Nationalization may be a more market-friendly solution," wrote Roubini, who also noted that the nationalization model was successfully used by Sweden during its banking crisis in the early '90s. "It creates the biggest hit for common and preferred shareholders of clearly insolvent institutions and … it provides a fair upside to the taxpayer."

The biggest danger in not nationalizing banks, Roubini continues, is that many of the banks will become "zombies" that are insolvent but are still being animated by taxpayer money. Without restructuring, these zombie banks would continue to be run poorly, and frozen credit markets would be unlikely to thaw.

So if the nationalization solution presents a better alternative to the Geithner plan, why isn't it being employed? 

There are two plausible explanations, and both are depressing. The first explanation is the most cynical one: that Geithner is protecting his friends within the banking industry from suffering the consequences of their poor decision-making. Baker sums up this argument succinctly: "Bankers are powerful supporters of the Democratic Party, and therefore [they think] it is good to help them."

The other explanation is that the Obama administration is so determined to transcend traditional partisan politics that it has bought into the false notion that America is an intractably "center-right" nation that will not tolerate massive government intervention into private institutions. President Barack Obama gave credence to this explanation during a recent interview with ABC News.

"Obviously, Sweden has a different set of cultures in terms of how the government relates to markets, and America's different," said Obama, explaining why the U.S. was not following the Swedish model for financial rescues.  "What we've tried to do is to apply some of the tough love that's going to be necessary, but do it in a way that's also recognizing we've got big private capital markets, and ultimately that's going to be the key to getting credit flowing again."

A week earlier, Geithner was even clearer about the administration's priorities when he said: "We have a financial system that is run by private shareholders, managed by private institutions, and we'd like to do our best to preserve that system."

If Obama is sincere about this, then this is indeed a discouraging development. The president who once promised that he'd bypass ideology in favor of "what works" is sacrificing a solution that has worked in the past on the altar of "center-right" ideology.

See more stories tagged with: obama, bailout, financial crisis, geithner

Brad Reed is a writer living in Boston. His work has previously appeared in the American Prospect Online, and he blogs frequently at Sadly, No!.

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