Why Obama Is Low-Balling the Banking Crisis

By Robert Kuttner, Huffington Post. Posted May 11, 2009.

I recently spoke at a Federal Reserve conference in Chicago, on financial regulation. The keynote speaker was Ben Bernanke. Chairman Bernanke was unable to leave Washington, so he spoke live, via a giant TV screen, giving his speech a fittingly Orwellian cast.

This was the day that the results of the so called stress tests were released. Not surprisingly, Bernanke was upbeat, since restoring confidence was the whole political point of the stress-test exercise. No major bank was insolvent, and the 19 largest banks collectively needed to raise only about $75 billion in additional capital, although their losses might total as much as $599 billion. Citigroup, queen of the Zombie Banks, remarkably enough, was said to need only $5.5 billion in additional private capital. You could almost make up that paltry sum with executive bonuses.

At one point in his remarks, Bernanke, recounting just how rigorous the stress tests were, explained that "More than 150 examiners, supervisors, and economists" had conducted several weeks of examinations of the banks. That kind of let the cat out of the bag. If you do the arithmetic, that is about seven supervisors per bank, and all of the stress-tested 19 banks were hundred-billion and up outfits. When an ordinary commercial bank, say a $10 billion outfit, undergoes a far less complex routine examination of its commercial loan portfolio, it involves dozens of examiners.

So the stress test was not a set of rigorous examinations at all, but a modeling exercise using the banks' own valuations of their assets. The most serious outside observers think the hole in the banks' balance sheets is much larger than $75 billion or even the Fed's worst-case estimate of $599 billion in losses. The International Monetary Fund estimates the hole as more like 2.7 trillion dollars, and informed economists like Nouriel Roubini put the number at as much as 3.6 trillion.

Why is the Fed low-balling the problem? The hope is that by keeping the banks afloat for a few more months, and trying to entice private capital back to the table, the recovery in other parts of the economy will spill over onto the banks. But the greater likelihood is that weakened banks will continue dragging down the rest of the economy.

Despite talk of "green shoots," - economic indicators not being quite as bad as expected, and the stock market up - most of the news is still pretty grim. Unemployment was up in April by "only" 539,000 jobs. Home foreclosures keep rising, with a total of eight million projected this year. Manufacturing is dead in the water. The administration's voluntary (to the banks) mortgage relief program will address only a fraction of the problem; and 12 Senate Democrats voted with the banking industry to deny bankruptcy judges the ability to modify the terms of a mortgage as a last resort - thus killing the one proposed stick in a program that is all carrots.

I also recently spoke at a convention of industrial construction companies. These are the people who build and maintain factories, power plants, and do other heavy industrial construction. I asked a room full of hundreds of executives how many saw signs of improvement in their order books. Not a single hand went up. Then I asked how many had had projects deferred because of difficulty getting financing. About two thirds of the people in the room raised their hands.

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Robert Kuttner is co-editor of The American Prospect.

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