Wall Street's False Armistice

The best names in Wall Street banking have announced victory. Their
crisis is over, back to business as usual. So why isn't the Obama White
House celebrating this good news? Because this may not be a lasting
peace for the president and his lieutenants. They are left standing in
the mudhole of financial ruin, still surrounded by the failing economy
and gradually losing their control over events. The leading bankers
worked out a rare deal for themselves that essentially says to the
government in Washington "heads we win, tails you lose."

If Jamie Dimon of JPMorgan Chase and Lloyd Blankfein of Goldman Sachs
turn out to be correct about the financial crisis, their institutions
emerge unscathed and restored to their old dominance over the US
economy. Minus a few old rivals who went bust.

If the bankers are wrong, Barack Obama will be the big loser--compelled
to rescue them again with still more public money. The big dogs of
banking know this, so does the president. That's why he didn't throw his
hat in the air when ten of the largest banks were allowed to pay back
the emergency aid they received from the feds, some $68 billion. The
financiers could thus declare themselves free and clear of the heavy
hand of government meddling. Another triumph of free-market capitalism.
A brilliant success for Goldman Sachs socialism. Barack Obama is holding
the bag for what happens next.

There is rough justice in his predicament. The essential bet Obama made
as president was to insist on a "voluntary" approach to rescuing the
financial system, picking up the main policies launched by his
predecessor. An odd-lot chorus of left and right critics (myself
included) urged Obama to step up and employ the full force of
government's emergency powers to take charge of the troubled system and
direct their behavior. Heal the wounded banks or liquidate them, use
government financing to insure the lending and investing needed to
finance economic recovery. Don't leave it to the bank executives who
will naturally take care of themselves first, maybe the country later.

Obama rejected that option. He was most reluctant to nationalize banks
or to assert full control of those zombies that government has had to
keep on life support. His political logic was obvious--maintain the
appearance of temporary interventions to assist private enterprise and
avoid any accusations of left-wing activism. The right called him a
socialist anyway.

What are the odds Obama will win his bet? Not so hot right now, despite
frequent pep talks from his economic advisers. If you think back to
where this crisis began last year and what the authorities described
then as their emergency response, big pieces are still missing in
action.

Bush's treasury secretary, Hank Paulson, stampeded the Democratic
Congress into providing $750 billion to soak up the rotten assets
burdening the balance sheets of the largest banks. That plan was not
pursued. The rotten assets are still largely there.

Obama's treasury secretary, Timothy Geithner, came up with an
alternative approach--a complicated Monopoly game in which government
would underwrite private investors to buy up the bad financial paper.
That didn't happen either. The bankers let it be known they would not
sell the stuff--not at discounted prices, not if it meant admitting the
depths of their true losses.

Meanwhile, the government has also ducked the explosive question of
derivatives--the casino-like "credit default swaps" that were very,
very profitable for banks like JP Morgan Chase but became the time bomb
threatening to blow up the entire system. The time bomb is still
ticking. The bankers don't want give up that lucrative business. The
Obama officials have not yet found the nerve to go against the bankers'
desires.

Finally, there is the real economy where most Americans dwell. Obama's
team is counting on a recovery in the second half of this year and his
advisors keep predicting it with increasing confidence. The president is
betting on that too. If his optimism is not confirmed by events, his
problems multiply. The stock-market restoration celebrated by the
bankers will begin to look like another financial bubble, driven by
false hopes. Banking problems will worsen and they will he back for
still more bailouts. And President Obama will have to take a second look
at his happy assumptions. He might start by replacing some of the
cheerleaders.