Can the private sector save the banks?

Lee Drutman: Can the private sector save the banks?

Tuesday, March 3, 2009

LEE DRUTMAN

WASHINGTON

THESE ARE HARD TIMES on Wall Street. All those big banks that once towered so high are now basically insolvent, and the only solution left seems to be for the U.S. government to inject a hefty sum of taxpayer money to prop up the banking system.

But . . . one small problem: Too much government ownership could be a gateway to “nationalization,” which, apparently, is un-American. You see, we in the good U.S. of A. believe in free enterprise, and we are not going to let a little thing like the massive failure of a sizeable chunk of private banking system fool us into letting the government start running our economy.

Ah yes. The private sector. And, speaking of which, shouldn’t that distinguished private sector be coming to the rescue of our once-grand banks any minute now, snapping up those “toxic” assets at market prices and getting our credit system humming again?

Okay, so the branding on these assets could be a little better, but come on! All you folks on Wall Street, who don’t like this whole nationalization thing: Don’t you want to show those crazy liberals in Washington that the private sector is not dead, that the free market still works, that government is not the solution?

After all, what would J.P. Morgan do? Well, back in 1907, Wall Street got caught up in a bit of a panic not entirely dissimilar to this one, and some large banks wound up insolvent. Morgan showed that the private sector was up to the task. He got a bunch of banker friends together and they pumped capital into the troubled banks alongside the U.S. Treasury, restoring solvency and confidence.

Unlike a century ago, of course, there are no strong banks left to help out the weak ones. But what we do have today are a lot of individual people who made an awful lot of money working on Wall Street. Surely, they could do their part for the free market?

Let’s do some brief accounting. The top 25 hedge-fund managers for 2007 each earned at least $360 million. And the top earner, John Paulson (no relation to Henry) earned $3.7 billion. Then you have the Wall Street CEOs. Merrill Lynch’s John Thain took home $83 million in 2007 (plus that fancy commode for his office). Goldman Sach’s Lloyd Blankfein took home $54 million. Then there’s Countrywide’s Tony Mozilo, who earned $410 million over several years by being at the center of the exploding mortgage business. But high-level compensation went pretty far down the organizational chart. And don’t forget about the bonuses: $18 billion even in 2008, $33.2 billion the year before. Wall Street made a lot of people millionaires.

And by the way: what, exactly, did they do in return for this money? As far as I can tell, Wall Street over the last 10 years consisted mostly of a sort of collective mania in which supposedly very smart people bought and traded insane amounts of complex financial products that they didn’t really understand, any more than they needed to understand the complex computer algorithms (designed by a bunch of even-smarter economics Ph.D.s) that told them they should be doing it.

Moreover, the more buying and selling they did, the more money they made. And as we all know, when you’re making millions in bonuses and compensation, you don’t ask silly questions like whether it is a good idea to leverage your assets 30- or 40-to-1 on the premise that home prices go up forever in excess of real income and people with no assets and no job can of course pay off a mortgage. Especially when it’s not even your own money you’re gambling with.

And so we are in a funny situation these days. We have a lot of people who got very rich on Wall Street during this disastrously delusional decade. And now, while the already deep-in-debt federal government struggles to clean up the sprawling mess the investors and bankers left behind, Wall Street still complains: Don’t nationalize!

Well, how about this for a solution: How about all those smart Wall Street bankers and investors who got so rich ruining the financial sector get together some of their own money and show us all how great the private sector is in correcting its own failures by setting up a fund to buy up the toxic assets and pump liquidity into the banks?

It’s good for taxpayers (less money for the bailout). It’s good for preserving private enterprise (no specter of socialism). And it might even be good for Wall Street (at the very least, Wall Street can improve its reputation by showing some spirit of civic responsibility; and who knows, maybe its denizens can even make some money buying up cheap assets).

For years now, conservatives have been talking up the importance of both personal responsibility and the power of private enterprise, while warning of wasting taxpayer dollars on big government. Well, if this isn’t a chance to put all those principles into practice, I don’t know what is. Come on, private sector! You can do it! Right?

Lee Drutman, a frequent contributor, is a research fellow at the Brookings Institution ( ldrutman@brookings.edu).

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