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The BAILOUT Isn’t Working – WSJ.com

August 20, 2011

BUSINESS WORLD AUGUST 20, 2011

The Bailout Isn’t Working

Bank of America is the canary in the coal mine.

By HOLMAN W. JENKINS, JR.

Let’s revisit the theory of the bailout. The government holds a safety net under the financial system, preventing a worse panic, with consumers and business cutting back spending more radically, with more people losing jobs, with more houses going into foreclosure.

It made sense on paper and underlies claims today that the government has been a net profiter from its bailout activities.

But it becomes apparent that the 2008 crisis isn’t over. And our bailout strategy? In one presumed lesson of the Great Depression, a splurge of deficit-financed spending is supposed to support the economy while consumers and businesses get over their shellshock. But as George Soros noted to Der Spiegel, the U.S. government in the 1930s wasn’t saddled with huge debt. Unless today’s deficit spending is visibly directed at projects with a positive return, he says, it just frightens the public that the government itself is going bankrupt.

As we now know, the Obama stimulus did not fulfill the Soros condition—it consisted mostly of transfers to support the incomes of people who weren’t working or government employees who were already employed.

Under bailout theory, housing was supposed to hit bottom, but the bottom would be higher than if the economy had lapsed into depression. But housing hasn’t been allowed to hit bottom, thanks to policies designed to foil foreclosures and keep people in houses they can’t afford and have stopped paying for. As a result, the housing and construction industries remain paralyzed.

Surely one lesson of the Great Depression commands common assent: Do as FDR did and support demand with public spending, but, for goodness’ sake, don’t do as FDR did and vilify the private sector while burying it under untimely and confidence-sapping policy initiatives.

Oops. We haven’t executed very well on this lesson either.

Which brings us to Bank of America, successor to Citigroup as the problem child of American megabanks.

When BofA agreed to buy Countrywide in 2008, the bailout was already in full swing. In carefully worded responses to investigators for the Financial Crisis Inquiry Commission (FCIC), then-CEO Ken Lewis said regulators showed “keen interest” in his planned takeover of the troubled mortgage giant, “but no one asked us to do the deal . . . nothing coercive.”

Mr. Lewis here is constrained by confidentiality rules. Wall Street analysts at the time were widely predicting Countrywide’s bankruptcy. As the Journal recently noted, “Regulators saw Bank of America as a savior for the tottering mortgage lender. They believed its failure could pose a major risk to the economy.”

Had it been allowed to fail, ironically, BofA wouldn’t be foundering today under a deluge of Countrywide-related lawsuits citing defective mortgages and snafu-plagued foreclosures. Claimants wouldn’t have BofA’s deep pockets to plumb. They would have ended up like the disappointed auto-accident litigants whose lawsuits were wiped out in the government-sponsored bankruptcies of GM and Chrysler.

BofA’s risk could amount to an estimated $30 billion or more, with no clear end in sight. Its stock has fallen by half this year, and by 30% in the past month. Bloody-minded analyst Chris Whalen, managing director of Institutional Risk Analytics, even says the bank should be seized by the Federal Deposit Insurance Corp. and liquidated.

Brian Moynihan, the bank’s latest CEO, said on a conference call last week: “Obviously, there aren’t many days when I get up and think positively about the Countrywide transaction.”

No kidding. His predecessor Mr. Lewis saw the Countrywide buy as a bet on housing and consumer credit bouncing back strongly. It was a bet on the bailout working. Banks like Bank of America are creatures of the safety net. They wouldn’t exist without it. What are deposit insurance, “too big to fail,” and the Fed’s liquidity heroics except an endorsement of institutions like BofA? After the Countrywide deal began to sour, according to an FCIC investigator, a BofA official even reproached the Fed for approving the deal and then not doing more to support it with regulatory favors.

BofA shareholders are paying an appropriately stiff price for a misjudgment of the sort that CEOs are paid big money not to make. But in another sense BofA is the canary in the coal mine. The bailout isn’t working. The Hail Mary is coming up short. Our warning of two years ago—”bank nationalization will soon be back on the agenda unless the economy picks up”—threatens to come true.

If the tea party crowd didn’t like the debt-ceiling hike, think how they’d react to Son of Tarp. And here’s a wildcard consideration for GOP voters: Whom do you want as your standard bearer circa September 2012 if another Lehman moment occurs in the middle of another presidential race?

via Jenkins: The Bailout Isn’t Working – WSJ.com.

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One Comment
  1. August 20, 2011 12:59 PM

    University of California Berkeley salary raises for chancellors faculty, Democrats, Republicans face mortgage defaults, 12% unemployment, pay reductions, loss of unemployment benefits.

    email your opinion to UC Board of Regents dianne.griffiths@ucop.edu

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