What is most damaging about this approach to an economy attempting to recover from a recession is that it ensures that the policy of tight money from the banks will continue for some time. Time is what is needed most, for the banks to earn their way out of their loan losses and insolvency problems -- if they decide not to quickly write off the bad loans, which is, quite apparently, going to be their choice.
In Japan, after their banking crisis of 1994, it took more than a decade for the banks to repair their balance sheets and resume normal lending, thus retarding economic growth for decades. And this is exactly the plan that Geithner and Larry Summers have proposed for the current crisis. If you remember, Hank Paulson, the Treasury Secretary at the time, had announced that the $700 billion TARP funds would be used to buy toxic assets like bad mortgage loans from the commercial banks. But this never happened and now the amount of bad bank loans has increased into the trillions. Immediately after receiving authorization of the funding for TARP from Congress, Paulson reversed direction and decided to make direct equity investments in the banks rather than using the TARP funds to acquire their bad loans.
So where are the trillions of dollars of bad loans that the banks had on their books?
They are still there. The Federal Reserve took possession temporarily of some of them as collateral for lending to the banks in an attempt to clean up the banks for their supposed "stress tests." But as of now, the trillions of dollars of underwater mortgages, CDOs and worthless credit default swaps are still on the banks' books. Geithner is going to the familiar "bank in crisis" playbook and is hoping that the banks can earn their way out of their solvency problems over time -- so the banks are continuing to slowly write off their problem loans but at a rate that will probably take decades to clean up the problem.
And this is where defeating Elizabeth Warren's nomination becomes critical for Geithner. For Geithner's strategy to work, the banks have to find new sources of profitability in their business segments to balance out their annual loan loss from their existing bad loans in an environment in which they continue to suffer new losses in prime residential mortgages, commercial real estate lending, sovereign debt investments, bridge loans to private equity groups, leverage buyout lending and credit card defaults.
The banks have made no secret as to where they will find this increase in cash flow.
They intend to soak their small retail customers, their consumer and small business borrowers, their credit card holders and their small depositors with increased costs and fees and are continuing many of the bad mortgage practices that led to the crisis (ARM's, option pay deals, zero down payments, second mortgages, teaser rates, etc). American and Banking Market News reports this week that the rule changes in the financial reform bill may lead banks to start charging fees that had essentially disappeared from the industry early in the new millennium -- such as fees for not meeting minimum balance requirements on a checking account, or reinstituting fees for certain online banking transactions that are currently free, or charging to receive a paper statement, or to talk to a live teller, as Bank of America's CEO has recently proposed.
However, it is exactly these types of unwarranted fees on small consumers and poorly designed products that Elizabeth Warren would certainly fight against as head of the new consumer finance protection group. And it is why Tim Geithner sees her as so threatening. For unless the banks are allowed to raise fees and charges on their smaller consumer customers, Geithner's and Summers' scheme for dealing with the banking crisis by hiding problem loans permanently on the banks' balance sheets will be exposed for what it is: an attempt at preserving the jobs and stellar incomes of current bank executives -- at the cost of dragging out this recovery needlessly for years into the future.
For the investment banks that are lacking small consumers and depositors to soak, Geithner and Summers have offered an environment with fewer competitors, more dominant market shares for the surviving firms, and near-monopoly pricing of their investment banking and derivative products to corporate clients and institutional investors to ensure continued and increasing profitability and growth.
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