In Punxsutawney, Pennsylvania, there lives a fat rodent called Phil whose job it is in the middle of every winter to tell us how much longer we must suffer through the cold and dark until spring. Phil is a groundhog and his annual prediction is taken very seriously. There is even a celebrated film about him, starring Bill Murray.
But this year Phil has been usurped by Barack Obama and Ben Bernanke. The President and his bearded Federal Reserve chief emerge daily from their offices like Phil from his hollow tree stump to tell us that ‘green shoots’ are poking through the hard and frozen earth despite obvious signs that winter, economically speaking at least, will be with us for a long time to come. Central to their claims that the worst of the downturn is over is a small amount of evidence that seems to show credit markets easing and banks beginning to lend again. This in turn has helped to arrest the precipitous decline of the housing market, and has spurred a little surge of consumer spending in certain corners of the market.
Many leading economists not only disagree with Obama and Bernanke’s rosy outlook, however; they are making jokes about it. At a recent conference in Philadelphia, Diane Swonk, the chief economist at Mesirow Financial, quipped that there are indeed three areas of the consumer economy where spending has started to increase: ‘Guns, condoms and alcohol.’
Joking aside, Swonk went on to put things in perspective. ‘We’ve gone from a sense of free-fall in the fourth quarter of 2008 to a point where we have pulled the ripcord and the parachute has opened. But we don’t know where we’re going to land, or whether it’s going to be in enemy territory,’ she said. Swonk’s analogy is spot on, and no more so than for America’s still troubled banking sector. Indeed, the biggest US banks, Bank of America and Citigroup, are not so much hovering over enemy territory as about to come crashing down on a hostile machine-gun nest — despite what Obama, Bernanke and the stock market may feel.
And Swonk is not alone in her analysis. Paul Krugman, the Nobel laureate Princeton economist and New York Times columnist, not only thinks Obama and Bernanke’s optimism is misguided, but also that geeing us into a falsely positive mood could be more dangerous than facing up to the facts — no matter how unpleasant they may be. Krugman believes the scale of the crisis has now overwhelmed the government’s response, and the best that can be said is that things ‘are getting worse more slowly’. On a recent trip to Beijing, Krugman pulled reporters to one side and gave them his version of the frightening truth. ‘We’re doing half-measures that help the economy limp along without fully recovering, and we’re having measures that help the banks survive without really thriving,’ he said. ‘We’re doing what the Japanese did in the Nineties.’
That is to say, the government has doled out unimaginable sums of money to get the credit wheels working again, but it has not followed through with the ‘systemic changes’ Obama and his Treasury secretary Tim Geithner both promised. Put more simply, they have tackled a problem of debt with trillions of dollars more debt. Nothing else has changed.
Obama and Geithner have failed to make the banks accountable for their actions. Restrictions placed on executives who accepted the ‘Tarp’ bailout are already virtually meaningless, as the banks do everything in their power to pay the money back so as to be free to return to their former ways.
Elizabeth Warren, chairwoman of the congressional oversight committee monitoring the $700 billion Tarp plan, has called for the removal of top executives from Citigroup, AIG and other institutions that received government funds, in a damning report that cast doubt on the administration’s approach to saving the financial system. Warren, a top Harvard law professor, also wants shareholders in those institutions to take the pain if the financial rescue is to succeed. ‘It is crucial for these things to happen. Japan tried to avoid them and just offered subsidy with little or no consequences for management or equity investors and this is why Japan suffered a lost decade,’ Warren told me. She believes there are fundamental problems with the policy of Geithner, whom she claims has offered ‘open-ended subsidies’ to some of the world’s biggest financial institutions. ‘There are many dangers inherent in that approach,’ Warren said.
Her report, published last month, examined how other financial crises were overcome, notably the Swedish and Japanese banking crises of the 1990s, the US Savings and Loan crisis of the 1980s, and the Great Depression. ‘We concluded that to successfully overcome these crises, three things had to happen,’ Warren said. ‘First, the banks must have confidence that the valuation of the troubled assets in question is entirely accurate, then the management of the institutions receiving subsidies from the government must be replaced, and thirdly the equity investors are always wiped out.’
Warren is worried that banks will not be able to return to health while they are being fed fat government subsidies. ‘When are they going to say enough?’ she demands. ‘This is a serious problem with open-ended subsidies. When will they stop?’
Warren said that her burgeoning relationship with Secretary Geithner is ‘inching forward’, adding that she did not want to be too hard on him at this early stage. She added, however, that Geithner must realise oversight is a significant part of the recovery process and must address the issues raised in the report.
‘The very notion that anyone would infuse money into a financially troubled entity without demanding changes in management and operations is preposterous,’ she said.
But there are no signs that Obama, Geithner, Bernanke or anyone else in Washington is taking Elizabeth Warren, Paul Krugman or their fellow doubters seriously. Until they do, we might as well hand the job of heralding the green shoots of spring back to the expert — if anyone can convince Punxsutawney Phil it’s worth coming out of his tree stump into such a bleak economy.