killer buffalo

There’s a rule of thumb at the Federal Reserve: if it looks like a recession, swims like a recession, and quacks like a recession, it’s probably a period of slower long-term growth in an economy of otherwise sound fundamentals.  The corollary is that it’s probably also the fault of Former Reserve Chairman Alan Greenspan.

Its government-led solution—which looks like bank nationalization, swims like bank nationalization, and quacks like bank nationalization—isn’t bank nationalization.  It’s a financial industry recovery program led by President Obama.

The problem is that Mr Obama’s program prevents Wall Street firms from differentiating themselves.

Although the Treasury has been reluctant to confirm reports from large New York banks, many healthy ones claim they were pressured to accept funding from the Troubled Asset Relief Program (TARP).  Others reported that after being asked to participate in the program, funds “showed up,” forcing involvement before a decision had been reached.

Then, when healthy banks like Goldman Sachs and J.P. Morgan requested to pay back TARP money, Treasury Secretary Geithner said that Mr Obama’s administration would only accept repayment if it was in the best interest of “the [credit] system as a whole.”  Mr Geithner’s worry with early reimbursement is the same one that led him to advocate that all large banks accept government financing in the first place—that a few banks rejecting or refunding loans would show consumers which banks are most stable and trigger runs on those that aren’t.

Indeed struggling banks can’t turn a profit if companies aren’t willing to do business with them.  However trying to hide weak ones behind their healthier peers is dangerous and shortsighted.  When stockholders see uncertainty, most assume the worst; that’s why the Dow Jones dipped more than 50% from October of 2008 to last March and why massive Bank of America losses set off declines in Goldman Sachs stock prices last year.  It’s also why President Lyndon Johnson signed into law the Freedom of Information Act of 1966.

We’ve known for more than forty years that markets are unpredictable when denied information.

But instead of undergoing a deep analysis of Wall Street banks to inspire confidence in investors, the Federal Reserve’s Supervisory Capital Assessment Program, known as the “stress tests,” seek to further equalize banks by publicly revealing only certain findings, presumably the positive ones.  The logic is the same that Mr Johnson implemented during the Vietnam War—that releasing exclusively good news leads people to assume that none of it is bad.  Warren Buffet won’t fall for that one.

The stress tests’ positive findings will provoke some level of differentiation among America’s banks, even if that drains business from feeble ones, thereby making the financial bailout more expensive.  As Americans will soon discover, there’s no alternative—forcing profitable firms to accept money they don’t need so that firms that need government money don’t look bad accepting it, makes everyone look unprofitable.  Everyone’s share price will reflect that.

If Mr Obama and the Federal Reserve decide not to reveal any information that the stress tests produce and the Treasury rejects repayment from J.P. Morgan and Goldman Sachs, they may succeed in dressing all banks in the same clothes enough that they look alike.  In effect, that will amount to nationalization of America’s financial landscape.

Even though that route will likely preserve more finance jobs, it will stifle competition and the motivating threat of bankruptcy that Mr Geithner has been reluctant to impose.  In that case, whether or not Mr Obama calls it nationalization, Bank of America will have an all-too-appropriate name, and its customer service lines may start to resemble those at the Registry of Motor Vehicles.

If it looks like it’s run by the government, swims like it’s run by the government, and quacks like it’s run by the government, guess what?

-David Lamb

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