The Banks Need to Start Lending Out the Federal Bailout Money They're Sitting On

David M. Smick, author of "The World Is Curved: Hidden Dangers to the Global Economy" writing a column in the Washington Post reminisces on a conversation he once had with former Federal Reserve Bank Chairman, Alan Greenspan in the early 1990s in which Smick asked Greenspan "what he thought of the Reagan administration's economic program? Greenspan's reply surprised Smick: "Greenspan theorized that the paradigm shift that moved the 1980s toward greater optimism came largely from something unanticipated. In 1981, President Ronald Reagan fired striking air traffic controllers. This act could have instantly produced a nationwide transportation walkout with devastating economic consequences. Everyone held their breath. But the strike didn't happen. At the time, American businesses had been written off as competitive dinosaurs. But now they had the political green light to restructure and become lean and mean. Economic optimism became infectious." Smick uses this story to suggest that: "Barack Obama desperately needs his own paradigm-shifting spark." Smick observes that: "for the first time since the 1930s, we have entered a period of demand destruction. Increased fiscal stimulus is essential, yet new roads and bridges, more generous unemployment insurance, and tax credits hardly constitute "audacious" policymaking" because "American consumers are undergoing long-term retrenchment. They are forgoing spending in an effort to replenish the $10 trillion in collective household wealth they have lost. Consumption patterns may be returning to the lower levels of previous decades. That could mean that even a $1 trillion package may be far too small to do more than keep the contraction from worsening." Smick suggests: "... there's a larger point. Economies are driven by more than numbers -- the size of either stimulus spending or interest rate cuts. They are driven by psychology. Right now, psychologically speaking, Americans see the U.S. financial system and the larger global system as a bus racing down an icy mountain road toward a village -- with no one behind the wheel." Smick is prodding Obama to make "a big play. The place to begin is by confronting our banking system -- possibly even breaking up the financial behemoths considered "too big to fail." Our banks are sitting on mountains of capital. Taken together, their excess cash reserves normally amount to $3 billion to $7 billion. Astonishingly, those reserves today are estimated to exceed $800 billion, a portion of which is our bailout money. We have moved from reckless financial risk-taking to a situation even more dangerous: no financial risk-taking. Many suspect that this cash buildup indicates that the banks' off-balance-sheet debt exposure is far larger than acknowledged." Obama needs to knock the banks from their status as "noble institutions." Obama must make it crystal clear to the American public that: "Today's bankers have shown themselves to be devoid of leadership skills and, in some cases, common sense. Who, moments after receiving a bailout, would send their executives on a spa vacation? Or rush out to double their investment in a Chinese bank?" Obama has got to give the banks a hard and swift kick in the pants of their expensive business suits if he wants to gain the public's trust that he really cares about them and he must put some fear into the bankers to get moving and help the economy by using the power of the "bully pulpit ... to do with the bankers what JFK did with the steel executives. The bankers say they won't lend, or are imposing extraordinarily tough terms on borrowers, because 2009 will be a tough year. Urge them, at a minimum, to help reduce mortgage rates and increase refinancing. How? By using their Troubled Asset Relief Program bailout funds to buy Fannie Mae and Freddie Mac debt. There is no excuse for not doing so. The debt is now explicitly federally guaranteed." Obama cannot let: "The bankers say that government regulators are conflicted. Some demand further capital set-asides and less lending; others just the opposite. Given the collapse of the economy, we cannot afford this argument. It's time for a regulatory decision that encourages lending. Worry about bank capital standards after recovery begins." Obama must not allow Bankers to dictate their pace of lending. Loans are needed now and the banks have plenty of money in reserve to deny loans and stop demanding exorbitantly high interest rates on borrowers. When the banks blame their inactivity on "our financial architecture." And ask questions as to: "Who, globally, should decide how much financial leverage is too much vs. how much is dangerously inadequate? What is the future of securitization and can this process be standardized and made more transparent? Can a more reliable market for derivatives be established? Is there an alternative to today's hapless, conflicted credit rating agencies?" Obama must respond with decisive and specific answers that will put the onus on the banks for failing to provide loans that will help end the recession. Smick believes that: "Obama needs to lay out for the banks the potential political risk of the status quo." He has to implant "this scenario eight to 10 months from now" in the collective minds of the banking industry. Obama needs to make his point that if unemployment rises to 10% "with mountains of bankruptcies and the banks still not lending." there will be severe consequences imposed on the banks. Obama will allow the Democrat controlled Congress "to break up the banks -- and remove current management." Smick assesses the lead up to, and the current economic situation: "The financial crisis has entered a new phase. From August 2007 to August 2008, it was only a crisis. Since September, things have shifted to a full-blown panic. Nobody trusts anybody, or any institution. That is why Obama needs the big play, a policy with a psychological "wow" factor. He needs to shock the flat-lining patient. An expanded version of Washington's usual bag of fiscal tricks may not be enough." Smick's analysis and call to Obama to make "the big play." Should not go unheeded. The economy is in a precarious position at this time and only by convincing the banks to take action as a part of a well-planned strategy can Obama lead us out of the economic troubles that are causing our recession and to do so Obama needs to restore "economic optimism" again.