Friday, March 27, 2009

Drawing a Line in the Wet Concrete

Drawing a Line in the Sand...a phrase everybody knows, yet nobody knows where it comes from. Some say it stems from the Alamo, when William Barret Travis drew a line in the sand with his sword, urging those who were willing to stay and defend the fort to step across it. Many historians suggest that it stems from the Roman Empire, when one of the Macedonian kings, a bit short of cash, decided to invade Egypt, then a Roman protectorate. His army was met at the border by a lone Roman senator named Popillius Laenas, who ordered the king to withdraw. The king began to stall for time, so Popillius Laenas drew a circle in the sand around the king and demanded that the king agree to withdraw his army before he stepped out of the circle. The king, apparently impressed by the senator's nerve (or, more likely, by the Roman Empire in general), withdrew.

Why the history lesson? Because as our parents and teachers have told us time and time again, "those who don't learn from the mistakes of history are doomed to repeat them," or something like that. And when it comes to the credit crisis, and the possible nationalization of the U.S. banking system, there is a lot of history to learn from. As this article from New York Times writer Alan Blinder suggests, nobody is really talking about nationalizing the entire US banking system (although I'm sure Rush Limbaugh is accusing Barack Obama of that desire as I write this).

As Blinder points out, the success that Sweden had in nationalizing banks in the 1990s stemmed not necessarily from the process of nationalization, but rather the efficiency with which they were able to carry it out. Sweden only had a handful of banks to deal with. The United States has over 8,300. Now even though most would not need nationalization, because not all are in financial turmoil, the question arises, "where do you draw the line?" If you only elect to nationalize the 5 sickest banks, what happens when the sixth sickest bank comes calling? Do you let it fail? Surely market speculators would sell its stock to the point where it would fail if if they knew you weren't going to come to its rescue. And so then if you save number 6, what about when numbers seven and eight come calling for the same reasons?

This would essentially be like drawing a line in the sand, only to revise that line at some arbitrary point in time. Not only that, but the government would essentially be doing the same thing as what they are doing with the homeowner bailout....rewarding those who were most irresponsible at the expense of those who were responsible.

If we are really to learn from history, we should know that drawing a line in the sand itself is part of the problem. All we have to do is look back to the actions of Hank Paulson and Tim Geithner. As we discussed in a recent blog post, their misdirection and/or seemingly constant changes of heart in what to do and who and how to help with bailouts made the economy, and the financial markets, even more shaky than they already were by their own doing. For you see, drawing a line in the sand is as fleeting as the wind that can wipe those same lines away. They can be fudged, revised, redrawn and forgotten almost as soon as they are drawn. Suffice it to say, that is simply the antithesis of stability, which is what we really need in the long run, be it for better or worse in the short run. We don't need a line drawn in the sand, we need a line drawn in wet concrete; One that isn't so reversible after a few hours time. Study history, contemplate the likely response/fallout of each choice, and then make the best decision possible. Oh, and then stick to it.


bill said...

So where do you want to draw the line in the concrete? I'm asking seriously because I don't think you say in the post. This year, the FDIC has taken over approximately 20 banks and liquidated most if not all of them. It's actually required by law. Law that has existed for many years and served us well during the previous banking crisis. The FDIC is not allowed to permit undercapitalized banks to operate. And it's not allowed to take over banks that are well-capitalized. So that kinda answers the question about where to draw the line. I'm more concerned that somehow we are stepping away from being a nation of laws, not men. That's a line that is much scarier than this banking crisis.

Llenrock Blog said...

I don't for a second to pretend to be smart enough to answer exactly WHERE the line should be drawn, only that it SHOULD be drawn somewhere after careful consideration of options and consequences of actions.

While your points are all correct and well-taken, it is my contention that the government cannot afford to let the BIG unhealthy banks to fail because of their vital importance to our economy. Therefore they have and may continue to get bailed out or taken over altogether. The question of where to draw the line comes from what number of the top unhealthy banks are actually vital to our economic health. Are the top 3 vital? the top 5? the top 10? Who determines this and how?

Obviously, nobody cares about letting the little unhealthy banks fail, because their impact on the overall economy is minor. Ironically, many community banks are actually doing quite well because they didn't (or couldn't) overexpose themselves.

Unfortunately, it is the big national banks vital to the economy that are the unhealthy ones. And so how many of them constitute being vital to our economic health and recovery will be the question of "where to draw the line."

If this is speculative, and arbitrary, whenever the line IS drawn, the banks who are on the border line of being fiscally solvent will likely become insolvent due to their stock price plummeting on the news of no government help, and so these banks must be allowed to fail since they were not theoretically deemed "vital" to the economic recovery effort.