March 5 will be the 76th anniversary of FDR's declaration of a Bank Holiday. His sudden, dramatic move, announced the day after he took office, saved the national banking system, ended the American credit crisis of the early 1930s, and opened the door to begin a return to more normal economic times.
A similar move by the Obama Administration is needed to clean out the toxic financial instruments now clogging up the financial system and to create confidence that the system which remains is sound. The Administration needs the boldness and courage to lead in the face of determined opposition. Today, Obama has the public support to be tough; success will be its own reward. If efforts at moderation and bipartisanship prevent the needed success, he may not have the support to be tough in the future.
For more see:NT Times Editorial and Roubini Article in WSJ
Franklin Roosevelt was sworn into office March 4, 1933. In the months preceding his inauguration, bank failures throughout the nation were accelerating. In case after case, runs on banks led to bank failures, often of banks which held sound long-term assets but were unable to turn them into the short-term cash needed to satisfy the run on the bank. The day following the ceremony, Roosevelt announced his famous Bank Holiday. All banks were ordered to be closed by presidential proclamation for a short period of time. During the closure, the banks were examined by Federal bank examiners. Those which were found to be sound were allowed to reopen with the additional security of Federal deposit insurance and access to shorten-term loans from the Federal Reserve to cover possible short-term needs, such as a bank run. Those which were not sound did not reopen.
The effect was twofold. Substantively, insolvent banks were not allowed to reopen. The banking system was cleansed of insolvency, and those banks which did reopen were "certified safe" by the Federal government with the added deposit insurance protection. But, even more important, the substantive action combined with the dramatic way in which it was taken, restored confidence both in the banking system and in the Federal government. Walter Lippman wrote, "In one week, the nation which had lost all confidence in everything and everybody, has regained confidence in the government itself."
The Bank Holiday did not cure the Depression, but it did cure the financial crisis, which was a prerequisite to the further efforts to cure the Depression. Although Roosevelt's efforts for the remainder of the 1930s were insufficient to actually restore prosperity, they did improve the economy and lay the foundation for the huge expenditures of Lend-Lease and World War II which did, finally, bring prosperity. Without the Bank Holiday and the solution to the financial crisis, neither the improvements nor the final return to prosperity would have been possible.
Economists today consider a solution to the credit crisis as one of the essentials to a return to prosperity.
Unfortunately, the Obama Administration not yet announced an understandable plan to accomplish this essential goal. The much ballyhooed Geithner announcement earlier this month was a dud which sucked any drama from the Administration's efforts and accomplished nothing.
The Administration appears unable to make up its mind what to do. While it seems to vacillate (the kind of word we will hear later from the right), the right-wing has begun its drumbeat of propaganda designed to protect the financial interests of the bankers who have brought their institutions to the verge of ruin. Any consideration of taking over and straightening out the banks is now branded as "nationalization" and attacked in advance by commentators inveighing against the inability of government bureaucrats to run sound banking operations. Hello! It wasn't the bureaucrats who brought the banks to their present sorry state.
Interestingly, conservative economists like Greenspan have begun to suggest that temporary nationalization may be the only answer. Today's Wall Street Journal features a major Op-Ed page interview with Nouriel Roubini explaining why temporary nationalization will be necessary.
But while these trial balloons indicate some support for a possibly necessary but politically difficult solution, the White House, in response to another market decline, issued a statement distancing itself from consideration of that alternative.
In a Bank Holiday scenario, sound banks would be certified safe and continue operation in the hands of their private owners.
Only unsound banks (whose private owners have lost their ownership interest due to mismanagement) would be taken over by the government to be rejuvenated. The takeover would be temporary, enough time to split off the toxic assets from the remainder of the bank, reorganize and recapitalize the remainder into a new bank and get it into operation. After a short period of time, the government equity created by government infusions of capital would be sold into the private market and the bank would return to private ownership.
Meanwhile, the toxic assets would be turned over to a long-term work out organization which can (a) manage or restructure mortgages to keep homeowners in their homes and making payments, where practical, and (b) maximizing the long-term total return for the benefit of the original equity owners of the banks. If the long-term workout provides sufficient value, the shareholders might actually receive value for their otherwise lost equity. There is no bailout, but the equity owners have their best chance at receiving value for the toxic assets.
The Administration's reluctance to bit the bullet seems to be a feeling that it needs to be "moderate" and attempt to placate the right-wing. Surely, the vote on the stimulus bill should have made clear that this will never work. Efforts to be bipartisan are all well and good, but bipartisanship is a two way street. The R's want the administration to fail and want to blame it for the failure. They want to water down its proposals, making them less likely to succeed, and then vote against them anyway, so that only Obama will "own" the resulting failure.
The Administration needs the boldness and courage to lead in the face of determined opposition. It needs to chart a bold course to success and stick to it; in the spirit of bipartisanship, invite the R's, but don't cave in to them; when they won't support the needed efforts, let them vote "no;" the public will not support their obstructionism. Today, Obama has the public support to be tough; success will be its own reward. If efforts at moderation and bipartisanship prevent the needed success, he may not have the support to be tough in the future.
Finally, the organized right-wing is doing a great job of keeping its talking points before the public. Fixing the banks is "nationalization," the stimulus bill "is not stimulative," "generational theft," "destroying our children's future," "taking money out of the economy," stop the bailouts, etc. Obama is doing a lot to get his message across, but most of what he says are seen and heard only as soundbits, not really in context. He and the Democrats need to be sure they are truly in front of the propaganda curve. A modern version of the fireside chat would be welcome -- his upcoming speech this Tuesday night is a great time to pull everything in perspective.