Honing Capitalism - BAC vs. Fed

Political rhetoric has moved beyond socialism vs. capitalism. Instead, it centers on how to best hone capitalism for the common good. This insight comes directly from Barrack Obama’s autobiography. And in that context, it might just be semantics, replacing the term “socialism” with “honing capitalism for the common good”. The main difference, however, is that people will often have a definitive stance on socialism; but no one quite knows how to hone capitalism for the common good. This is why the Bank of America / Federal Bank scandal has emerged as bar none the most fascinating subplot of the financial collapse.

The basics of the scandal have been unfolding for some time: In September, BAC announced plans to acquire Merrill Lynch (ML). As the crisis worsened in the winter, BAC considered backing out based on ML’s projected 4th quarter losses. Paulson (previous US Treasury Secretary) and Bernanke (current Fed Chairman) pressured BAC to go through with the deal, threatening to withhold bailout should the economy worsen. BAC complied completing the deal around New Years. 2 weeks later, ML announced astronomical quarterly losses of about $20 billion. This outraged BAC shareholders who blamed CEO Ken Lewis, and Lewis in turn blamed Paulson and Bernanke. On top of all this, recently uncovered emails from the Fed show that they applied much more pressure to BAC than was previously thought, going so far as to threaten to remove Lewis. In the meanwhile, BAC, unsurprisingly, has received upwards of $50 billion in bailout funds, along with guarantees of twice that should they face future losses.

Bernanke and Pualson justified their actions as necessary to avoid widescale financial collapse. Afterall the failure of The Bank of the United States catalyzed the Great Depression in 1930. And it is thought that in order to avoid another Great Depression, we must prevent such large scale failures.

There is one view of history that says it’s determined by large-scale historical events. If you could’ve prevented the event, this line of thought goes, you’d have prevented its consequences. A more subtle view sees large historical events as the effect, rather than cause, of underlying social movement. Going by the latter, it doesn’t matter which large scale events you might prevent, because the underlying problem stays the same.

The BAC/ML merger didn't benefit the greater good at BAC's expense. In some ways, it has made the whole system worse. Going into the crisis, BAC was not only the healthiest bank in America, it belonged to a rare breed of successful commercial banks doing business with tens of millions of everyday people. Loading it up with ML's debt was the equivalent of further dragging down our banking system's best fruits with its worst apples. (Ironically, in 1933 the Glass Stegal act attempted to hone capitalism by doing the opposite, forcing the separation of commercial and investment banking.)

The underlying story of the financial crisis is that institutions which were too big to fail misread their risks and were too interconnected to each other. Fair enough. But to the degree that separate institutions are indeed separate, forcing BAC to merge with ML is simply perpetuating the original problem (of interrelated systemic risk) albeit to the nth degree. Instead of cutting our losses with ML and maintaining one great bank, we have a formerly great bank forced to remain on life-support from the government.

Public bewilderment towards the financial crisis stems partly from the fact that no one quite knows what to do. It makes one nostalgic for the 1980’s when things were as simple – at least in retrospect - as Reaganism and Thatcherism vs. Socialsim. Current economic debate - in contrast to the public’s partisan divide on Obama approval ratings - has become less polarized and ideological, more ambiguous and murky, and more important all at the same time. As Greenspan – a self-described Republican-libertarian - pointed out, his job was similar to those of communist central planners, only he was controlling a relatively smaller piece of the economy.

It’s a point worth repeating that the current depression is more complex than most of us can wrap our minds around. And it reveals one of democracy’s flaws, which is that running a country requires more detailed knowledge than is commonly held by the public. Our successful economic recovery - similar to the post-WWII recovery following the Great Depression - is likely to leave the public with few lasting insights about the economy or how the world works. It’s in this panicked context that we see such strange behavior as the Fed’s pressure to force the BAC/ML merger – a scandal occurring at the main nerve of the crisis, the lasting effects of which are unlikely to be well known by the public and experts alike.

What makes this scandal unique is that it's not quite a financial one, and it is a political scandal but not in the regular sense. What, in the end, did Paulson and Bernanke have to gain by forcing the merger? It wasn't money, votes, or even popularity. It didn't spark public outrage like the Madoff or AIG bonus scandals. And the perpetrators weren't guided by partisan or ideological grounds as in the case of Acorn's voter fraud. Unlike any of the previous examples, the perpetrators' motives are not immediately obvious; you have to sit back and think about it before understanding why Paulson and Bernanke felt the need pressure BAC into the merger. And you also have to sit back and think about it before understanding why Paulson and Bernanke's actions were wrong.

-KJ

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Media (in order of appearance)

Photo: (1)Obama at the Texas book festival, 10/28/2006, by Mr. Wright; (2)Bank of America Logo, 08/19/2007, by Neubie; (3)fail, 09/29/2008, by rin3y; (4)Joan of Arc, 08/23/2006, by dbking;(5)Aghast, 08/28/2008, by Daveness98. Sphere: Related Content