It was already evident, but the papers Tuesday confirmed it: Treasury is using the bailout program to encourage bank consolidation. Simply put, Treasury (and presumeably its doppleganger, the Federal Reserve) adheres to the belief that bigger is better, or at least safer, in banking. And so despite some controversy that may ensue, more prosperous banks will be able to use the funds to buy other, weaker institutions. In short, the government is reaching into the market to insure certain results.
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So who cares? After all, in this fraught climate, bigger may well be better -- although some of the largest banks plunged deepest into the muck of subprime, credit default swaps, CDOs and CLOs. (And, in fact, the larger the bank, the tougher, by definition, it is to grow.) As we discovered with Lehman Brothers Holdings Inc., Washington Mutual Inc., American International Group Inc., Fannie Mae and Freddie Mac, and Wachovia Corp., the largest institutions -- commercial bank or not -- pose the greatest systemic risk. Lehman alone nearly brought the entire global financial system down; imagine a Bank of America Corp. once it merges with Merrill Lynch & Co. At the very least, a more concentrated banking system creates more concentrated pools of risk.
There are two kinds of nationalizations currently unfolding here: One, which involves the purchase of equity by the government, may well be temporary; two, and far more permanent and structural, is the creation of institutions that are too-big-to-fail. Those jumbo banks -- and they will apparently get larger in number and size -- will, by dint of their sheer bulk, become public utilities of sorts, with the kind of enveloping regulatory care and feeding necessary for any institution that can blow everything up. Moreover, consolidation insures a regulatory outcome. You'll need an uber-Fed to oversee a handful of uber-banks.
The argument that's made for this use of the funds is to urge consolidation to take the stress off the Federal Deposit Insurance Corp. That's a reasonable argument, but a very short-term one. But that's it? Or are we stimulating acquisitions as a reward for good banks and a punishment for bad, a sort of Darwinianism on steroids? The suspicion here is that this is a continuation of an old policy with new tools. In fact, it's been Fed policy, rarely articulated but self-evident, to encourage bank consolidation over at least the last two decades. In the Fed view, bigger is better, more efficient, more competitive. That was an extremely persuasive argument throughout the Alan Greenspan years at the Fed, as commercial banks amassed capital, created liquidity and appeared to be as unsinkable as, well, the Titanic. Oh well.
The real difficulty here is that there are good arguments and bad on both sides, but under the guise of the emergency, an extremely lame-duck Treasury and the Fed are making policy on the fly. OK, I understand that banking consolidation is not one of those issues that stirs the American soul right now. But the repercussions are large; and like much of the retirement system in this country, fundamental decisions are made over time by "experts" buried in departments and agencies that have profound long-term effects. Oftentimes, that's unavoidable and indeed the very reason we have administrative agencies. But is this one of them? Is the crisis so acute that Treasury feels it has to recast the banking system in the next two weeks -- or two months? Or is the debate over banking part of a larger reframing of the regulatory system that will occur in the next administration?
Like so many other decisions, this one comes back to Treasury Secretary Henry Paulson, who has struggled to find the line between aggressive and intelligent action and political overreaching. The legacy of Paulson may well be that he was a smart guy in a tough spot who meant well but lacked a certain political surefootedness -- or even awareness that he was operating in a political environment. (In this regard, Federal Reserve Chairman Ben Bernanke, who wil be around for awhile, has performed far more effectively.) As election day nears, that problem will only grow more serious. Very soon he's going to have to give up the struggle to the dreaded politicians. - Robert Teitelman
Robert Teitelman is the editor in chief of The Deal.
