http://www.nybooks.com/articles/archives/2010/dec/09/economy-why-they-failed/?pagination=falseThe Economy: Why They Failed
December 9, 2010
John Cassidy
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Given the nature of the policies that the Bush and Obama administrations had adopted, public anger was inevitable. By the end of 2009, almost all the big banks had repaid their TARP bailouts, but they continued to be the recipients of official largesse. With the Fed holding short-term interest rates at virtually zero, firms like Citigroup and Goldman Sachs could borrow money from one arm of the government (the Fed) or from investors (by issuing short-term commercial paper) for next to nothing and, by purchasing US bonds, lend it to another arm of government (the Treasury) at an interest rate of 3 or 4 percent. By playing “the spread,” any moderately competent Wall Street trader could generate large returns for his desk and a big bonus for himself without actually doing what banks are supposed to do: furnishing money to firms and funding capital investments. While bank profits were soaring, many businesses and individuals were still finding loans hard to come by.
The other losers in this game were those who had cash stashed in a savings account or money market mutual fund. “What we have right now is a situation where every saver in the country is, essentially, paying a huge tax to bail out the banking system,” noted Raghuram Rajan, the University of Chicago economist who, back in 2005, had issued a fateful warning about the dangers of a financial blowup. “We are all getting screwed on our money market accounts—getting 0.25 percent—and the banks are making a huge spread on nearly every asset they hold, because they are financing them at pretty close to zero rates.”
The Obama administration didn’t come out and say so, but enabling the banks to make big profits was one of its policy objectives. Rather than seizing control of sickly institutions, such as Citi and Bank of America, it had settled on a policy of allowing them to earn their way back to sound health, while also encouraging them to raise money from private investors. This was the rationale behind the controversial “stress tests,” which the Treasury Department and the Fed carried out in the spring of 2009; they were intended to find out how much new capital the banks needed to survive a deep recession.
In May 2009, when Geithner announced that the ten biggest US banks needed to raise just $75 billion, many economists had accused him of understating the banks’ remaining holdings of toxic assets. In fact, the official loss estimates were similar to those produced by independent analysts. But the government stress testers were assuming that other parts of the banks’ businesses, particularly their trading operations, would record greatly enlarged profits in 2009 and 2010, which would help them withstand big losses in real estate and commercial lending. Buried in the Treasury’s official report on the stress tests was the prediction that Citigroup’s net revenues in 2009 and 2010 would exceed by $49 billion its provisions for losses through bad loans. For Bank of America, the projected profit figure was $75.5 billion. For Wells Fargo, it was $60 billion.
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http://www.nybooks.com/articles/archives/2010/dec/09/economy-why-they-failed/?pagination=false