Stress Tests and the Nationalization We Got

In short, relationships between the government and the large banks have never been closer, with large amounts of money flowing in one direction, and complete co-dependency going in both directions. Those relationships are not entirely friendly, which is not surprising. In any crisis when public resources are called on to bail out the private sector, not all of the oligarchs will survive; Bear Stearns and Lehman have already vanished. But the winners - which should include Jamie Dimon of JPMorgan Chase and Lloyd Blankfein of Goldman - will emerge even more powerful and influential than before.

In rejecting “nationalization” (regulatory takeover and conservatorship), the government has not ensured a private, properly functioning banking system. Instead, it has muddled into a broken-down, undercapitalized system that is nominally in private hands, but is able to tap the state for apparently limitless support. And to date, that support has flowed on one-sided terms, with the taxpayer accepting downside risk but limited upside potential. No wonder bank shareholders are comfortable with this outcome.

As a result, the banks have largely preserved their existing management teams and bonus plans: on Wall Street, first-quarter accruals for bonuses returned to the levels of the glory years of 2006 and 2007. Creditors and counterparties have been kept whole, most notably through the AIG bailout. And shareholders have seen their share prices supported by the promise of sustained government support. The incentives we have ended up with are more similar to those of a nationalized system than those of a free market. Instead of state-owned coal mines run for the benefit of miners (the U.K. in the 1970s) or state-owned oil and gas companies run for the benefit of bureaucrats (the Soviet Union in the 1980s), we have state-backed banks in the U.S. run for the benefit of bankers and their creditors.

SIMON JOHNSON and JAMES KWAK, baselinescenario.com

 http://baselinescenario.com/2009/05/07/stress-tests-and-the-nationalization-we-got/#more-3561

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