Three Years After the Bailouts, A Weaker Banking System
Describing Germany in the aftermath of World War II, Howard Kershner noted in his essential book, Dividing the Wealth, that "This unfortunate country had been more nearly destroyed than any other in Europe. She had suffered the loss of many millions of her strongest young men and had seen a great part of her homes, factories and business buildings destroyed. City after city had been reduced to a mere skeleton and people were living in caves, cellars, Quonset huts and three or four families crowded into a dwelling intended for one."
But in addressing post-war Germany, Kershner observed that "In spite of all these handicaps, in a few short years Germany became the most prosperous country in Europe, if not in the world." Much like Germany, Japan's economy began to roar in short order after the war despite being in even worse shape. The latter was not thanks to the Marshall Plan (there wasn't one), but rather occurred due to a reduction in government spending in both countries (on their backs, the governments lacked funds to spend nor creditworthiness to borrow), reductions in the tax burden, and most important of all, currencies made stable by their peg to a gold-defined dollar.
The above bit of history is notable in light of the hysterics uttered by our failed Fed Chairman amid the struggles of U.S. banks three years ago. In a meeting with House Speaker Nancy Pelosi with an eye on securing her support of the bank bailouts, Ben Bernanke said "I spent my career as an academic studying great depressions. I can tell you from history that if we don't act in a big way, you can expect another great depression, and this time it is going to be far, far worse." Treasury Secretary Henry Paulson added on that "If it [TARP] doesn't pass, then heaven help us all."
What neither Bernanke nor Paulson understood, or were simply unwilling to acknowledge, was the market reality then that banks were an increasingly insignificant player in the market for credit. Indeed, at the time of a crisis authored by government error 80% of business lending took place outside of the banking system, according to Meltdown author Thomas E. Woods. Furthermore, while the Dow Jones Industrial Average sat at 10,482 on the day that TARP was passed, a week later it had fallen to 9,000.
More to the point, if Germany and Japan could emerge rather quickly from the death and destruction of war that robbed both of their most important (human capital) asset, can it be credibly said that the failure of one or many banks in the U.S. (despite no loss of lives, and a mere change in ownership at the failed financial institutions) would have set our economy back in any long-term way? It seems the question itself answers the supposed riddle, and when the proper history of 2008 is written, Bernanke and Paulson will loom large as the feckless authors of an economic malaise still with us.
The U.S. economy continues to struggle, and the bailouts are a significant reason why. That's the case because recessions, as painful as they are, are in fact a beautiful economic signal that tell us the economy is on the mend. The deeper the recession the more powerful the economic snapback; recessions the happy period when all the bad business concepts, all the improper investment, and all the misuses of labor are cleansed from the economy so that financial, mechanical and human capital can reach higher uses requested by the marketplace.
But much as Presidents Hoover and Roosevelt created a 10-year debacle now known as the Great Depression for seeking to use the money of others to shield Americans from near-term pain, so have the Bush and Obama administrations (ineptly aided by the walking, talking definition of economic crisis - Ben Bernanke) sought to do the same. And much like the 1930s, the economic pain continues three years after the "crisis" for market forces being blunted three years ago when they sought to rinse our economy of the illnesses that were restraining its advancement.
Looking at the banks, free markets have sought to minimize their economic role for at least a century, and probably more. Whatever their role, it's fair to say that thanks to bailouts of the sick ones, we've restrained the positive evolution of the banking system, and economic growth more broadly for so much economic talent remaining locked up in a sector that the markets have been vainly trying to resize and reshape.
Worse for the banks, the bailouts have merely delayed their eventual descent into irrelevancy. What banks and their political supporters missed in 2008 is that bailouts don't occur in isolation whereby the alleged benevolent government offers up cash, and then walks away.
In truth, once an institution is the recipient of government largesse, that business is no longer in the business of profit. Instead, for taking government money it serves political masters with no regard for profits; politicians and bureaucrats eager to use the institutions they saved as social concepts meant to hand out non-economic loans, hire based on gender/race over economic value to the organization, and charities meant to forgive non-performing loans made to individuals in arrears on debts. And then as if the latter weren't enough, banks now suffer 4,870 pages of new federal rules proposed by Washington through Dodd-Frank that is turning banks into compliance experts over profit creators.
Bank of America, essentially forced to swallow Merrill Lynch in 2008 on the way to modern questions about its survival, is but one of many financial institutions worse off for our federal masters having "saved" what they shouldn't have. The shares of other financial institutions are similarly down from previous highs as markets price just how handcuffed the sector will be going forward. Essentially the government saved banks in 2008, with an eye on strangling them later.
The great British political economist John Stuart Mill predicted all of this long ago. As he put it, "The only insecurity which is altogether paralyzing to the active energies of producers, is that arising from government, or from persons vested with its authority. Against all other depredators there is a hope of defending oneself." Banks sought government security in 2008, and they face much worse times ahead as the same government seeks payback in the form of coerced business activity that has nothing to do with profit.
Lesson learned? We can only hope.