The banking crisis: lunatics now running the asylum

Interesting column from Paul Krugman, one of the few people who talks sense at the moment.

So now we have a bank crisis. Is it the result of fundamentally bad investment, or is it because of a self-fulfilling panic?

If you think it’s just a panic, then the government can pull a magic trick: by stepping in to buy the assets banks are selling, it can make banks look solvent again, and end the run. Yippee! And sometimes that really does work.

But if you think that the banks really, really have made lousy investments, this won’t work at all; it will simply be a waste of taxpayer money. To keep the banks operating, you need to provide a real backstop — you need to guarantee their debts, and seize ownership of those banks that don’t have enough assets to cover their debts; that’s the Swedish solution, it’s what we eventually did with our own S&Ls.

Now, early on in this crisis, it was possible to argue that it was mainly a panic. But at this point, that’s an indefensible position. Banks and other highly leveraged institutions collectively made a huge bet that the normal rules for house prices and sustainable levels of consumer debt no longer applied; they were wrong. Time for a Swedish solution.

But Treasury is still clinging to the idea that this is just a panic attack, and that all it needs to do is calm the markets by buying up a bunch of troubled assets…

Krugman’s becoming increasingly vehement about this. Why?

Because I’m afraid that this will be the administration’s only shot — that if the first bank plan is an abject failure, it won’t have the political capital for a second. So it’s just horrifying that Obama — and yes, the buck stops there — has decided to base his financial plan on the fantasy that a bit of financial hocus-pocus will turn the clock back to 2006.

That’s the nightmare. I’m not usually a pessimist, but I have a sinking feeling that the people who are supposed to be in charge of this are really out of their depth. And — as Joe Nocera and David Brooks pointed out so eloquently yesterday — the politicians are, if anything, making things worse. Here’s Brooks:

You’d think if some tiger were lunging at your neck, your attention would be riveted on the tiger. But that’s apparently not how it works in the age of global A.D.D. As a tiger sinks its teeth into the world’s neck, we focus on the dust bunnies under the bed and the floorboards that need replacing on the deck. We live in the world of Perverse Cosmic Myopia, an inability to focus attention on the most perilous matter at hand.

The tiger, of course, is the collapsing world financial system. Americans actually have a falsely mild view of this crisis because the economy is worse abroad. The U.N.’s International Labor Organization projects between 30 million and 50 million job losses worldwide. Central European countries are teetering; Japan’s economy is horrifying; and the Chinese job creation machine is losing the race against its demographic pressures.

Brooks is critical of Obama.

The president of the United States has decided to address this crisis while simultaneously tackling the four most complicated problems facing the nation: health care, energy, immigration and education. Why he has not also decided to spend his evenings mastering quantum mechanics and discovering the origins of consciousness is beyond me.

The results of this overload are evident on Capitol Hill. The banking plan is incomplete, and there is zero political will to pay for it. The president’s budget is being nibbled to death. The revenue ideas are dying one by one, while the spending ideas expand. By the latest estimate, the health care approach will cost $1.5 trillion over 10 years and the national debt will at least double, while the Chinese publicly complain about picking up the tab.

But at least Obama is distracted by Big Issues. Congress, on the other hand, has lost its marbles…

The Washington political class has spent the past week going into made-for-TV hysterics over $165 million in A.I.G. bonuses. We’re in the middle of a multitrillion-dollar crisis, and our political masters — always willing to throw themselves into any issue that is understandable on cable television — have decided to risk destroying the entire bank-rescue plan because of bonuses that account for 0.001 percent of the annual G.D.P.

Even this is not the most idiotic of the distractions. For that, you have to look abroad.

Joe Nocera wrote an impassioned polemic against the righteous bloodlust which has gripped the House of Representatives over the A.I.G. bonuses.

By week’s end, I was more depressed about the financial crisis than I’ve been since last September. Back then, the issue was the disintegration of the financial system, as the Lehman bankruptcy set off a terrible chain reaction. Now I’m worried that the political response is making the crisis worse. The Obama administration appears to have lost its grip on Congress, while the Treasury Department always seems caught off guard by bad news.

And Congress, with its howls of rage, its chaotic, episodic reaction to the crisis, and its shameless playing to the crowds, is out of control. This week, the body politic ran off the rails.

There are times when anger is cathartic. There are other times when anger makes a bad situation worse. “We need to stop committing economic arson,” Bert Ely, a banking consultant, said to me this week. That is what Congress committed: economic arson…

Nocera’s point is that while the bonuses are indeed repulsive, they are a sideshow. And they will have the effect of ruining the chances of taxpayers ever getting their money back. For example,

During his testimony on Wednesday, Mr. Liddy pointed out that much of the money the government turned over to A.I.G. was a loan, not a gift. The company’s goal, he kept saying, was to pay that money back. But how? Mr. Liddy’s plan is to sell off the healthy insurance units — or, failing that, give them to the government to sell when they can muster a good price.

In other words, it is in the taxpayers’ best interest to position A.I.G. as a company with many profitable units, worth potentially billions, and one bad unit that needs to be unwound. Which, by the way, is the truth. But as Mr. Ely puts it, “the indiscriminate pounding that A.I.G. is taking is destroying the value of the company.” Potential buyers are wary. Customers are going elsewhere. Employees are looking to leave. Treating all of A.I.G. like Public Enemy No. 1 is a pretty dumb way for a majority shareholder to act when he hopes to sell the company for top dollar.

All of which brought Edmund Burke to mind. The reason we have representative democracy is to strike a balance between the need to respond to the public’s wishes and the risks of lurching on the tidal surges of public outrage. Congressmen (and MPs) are representatives, not delegates. We pay them to make up their own minds, to consider things in the round, to ponder the knock-on effects of policies — in short to think.