Sunday, 11 October 2009

Why "Bailout Nation" is Like Water Torture

Early on in this financial crisis (that has now "ameliorated" to become more or less just a protracted mess), the U.S. as a nation stood at a juncture. There were two roads that lay before us: A difficult one that would lead to more short-term pain, but better prospects for a swifter, and more fair, economic recovery. And an easier one that would minimize the immediate pain but that would prolong the necessary adjustments and fail to fix the inherent abuses that led to the crisis in the first place.

Of course we chose the second path. The U.S. has shown itself good at prescribing tough remedies to small weak countries in financial distress that need our help. Yes, metaphorically speaking, they should have their teeth filled without the benefit of Novacaine. But for ourselves, we want only the best in sedation dentistry.

The second path I think we should all agree to name "Bailout Nation," with the obligatory tip of the hat to Barry Ritholtz, who penned a book by that title. Because Bailout Nation, viewed largely, is a philosophy -- that's what we need to understand. There is "Take Your Medicine Nation" -- that would be an adherence to a more primitive (though arguably more just, compared with what we got) form of capitalism. But "Bailout Nation" describes a far different country: socialism for the financially powerful and entrenched.

The "Bailout Nation" approach has some foreseeable, and unpleasant, consequences. To wit: you can either clean up your banking system by punishing bondholders and zeroing out shareholders and encouraging a new wave of banks to take their place -- banks that presumably will act in a more prudent manner in the candy shop of risk. Or you can prop up the old and corrupt institutions and give them enough financial blood transfusions that their gray pallor finally clears, and they start to look healthy again.

By doing the latter -- propping up the old and corrupt -- the trouble is that you're very quietly and insidiously punishing the rest of the economy. That is because, as financial commentators are often noticing now, banks that have to earn their way back to good health also like to sit on their piles of gold, a bit more nervously and conservatively, and charge borrowers a higher rate of interest overall.

We have all seen the stories by now of the large banks putting a borderline usurious squeeze on credit card holders. The irony is being pointed out by financial reporters: these banks are borrowing at near zero percent, only to turn around and hit their subjects with 25, 30 percent interest rates. These wounded banks engaged in this practice aren't doing anything unexpected: they want to widen the "spread" (the difference between what they borrow at and what they lend at) to get healthier. The trouble is, they need this fat spread because they are in such a deep hole and we refuse to let them die (part of the "Bailout Nation" philosophy -- tenet number six, if you will -- is that "certain institutions will be deemed too big to fail and will be protected by the state").

The other problem I mentioned is that the banks simply won't lend out as much if they're ill. And this too we're seeing, as in this new MarketWatch article:
Banks Cutting Back on Loans to Businesses

And the money paragraph:
But if the decline [in lending] is mainly due to weak banks unable or unwilling to lend, then a turnaround in credit creation may have to wait until banks' balance sheets are repaired, a process that could be delayed by further expected defaults in consumer loans, mortgages and commercial real-estate loans.
So the large sick banks that we refuse to let perish will exert this subtle tax on economic growth, for the next umpteen quarters, punishing us for saving them. (Note: I realize that, in this climate, any bank would be more nervous about lending, but the sicker your balance sheet, the more tentative you're going to be -- and we've pretty much guaranteed that the sickest of the sick will be nursed along.)

There you have life in "Bailout Nation." We should get used to it. Instead of taking our pain all at once, we prefer to drag it out, so that the misery goes on and on. Like water torture, if you will.