Obama has made perhaps his first big mistake. It's time to bring the rest of the country up to speed.

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The Obama administration has made its first serious misstep. No, it wasn't the wooing of ingrate Republicans, or the dining with clueless reactionary pundits. It is much more significant. Faced with the failure of the Paulson-Bernanke banking bailout, the Obama administration has decided to double down. The new plan, described in broad outline by Treasury Secretary Tim Geithner on Tuesday, antes up another $1.5 trillion or more to keep the banks afloat. But it won't convince many that they are seaworthy.

The plan isn't likely to get the administration where it needs to go for two simple reasons. It is wrong about where we are starting from. And it is wrong about where we're going to. If you don't know where you are and don't know where you are going, it is very hard to get there.

The plan won't admit where we are: the major banks in the US are insolvent. They aren't addled by a temporary fever. They are broke. If they actually marked their toxic paper to the market price - where there is one - their losses would wipe out their capital, even including the billions kicked in by the government in the first round. Clearly, the Obama administration - like the Bush administration before it - hasn't accepted that reality.

The plan won't get us where we need to go: we need to restructure - and downsize - our financial sector. Its baroque excesses - billions in bonuses, golden parachutes, million dollar office renovations, $35,000 "commodes on legs," $50 million private jets, legions of employees - were constructed atop a housing bubble that finally burst. Now the banks and financial houses must be downsized, chastened, and regulated. As President Obama stated, "the party is over." But the administration's plan envisions a restoration, not a restructuring. We don't want to go there even if we could afford it.

Martin Wolf, the lead economics writer for the establishment Financial Times, notes that the plan was constrained by three assumptions: no nationalization, no losses for bondholders, no new money from the Congress.

No nationalization rules out the way the US normally deals with insolvent banks. The FDIC takes them over, replaces the management; the depositors are reassured, the shareholders take their losses to write off the bad debts. Then the FDIC restructures the bank, merges it or sells it back to private investors. It arranges an orderly and seemly burial. Without doing this with banks that are "too big to fail," the administration is left paying tribute to zombie banks that consume taxpayers' money while doing little if any productive banking.

No losses for bondholders means that taxpayers pick up the bill. With an insolvent bank, shareholders lose their investment. That's how the market works. If that isn't enough to cover the losses, then creditors take what is called "a haircut." A portion of the loan they made to the bank is written off or turned into equity (stock). But with neither the shareholders nor the creditors taking the hit, only taxpayers are left.

No new money from the Congress - surely a political reality with the rising popular fury at bailing out millionaire bankers - means that the plan is immensely complicated, combining guarantees from the Federal Reserve, small capital injections, inducements to lure private investors. But the whole point of the exercise is to restore confidence in the soundness of the banks. A jerry-built complicated package only makes everyone nervous that the whole contraption won't hold up.

How can Obama get back on track? The plan does have one potentially redeeming feature. It pledges that any bank requesting federal assistance will have to undergo what it calls "a stress test," a detailed assessment of the value of its holdings and liabilities. This is the first thing the FDIC does when it takes over a bank verging on collapse. An honest assessment allows the government to decide whether the bank is salvageable or not. (It is aided in this process by getting rid of the old managers who have a direct interest in covering up the depth of the hole they are in)

The Treasury could use this clause to "discover" that the banks applying for assistance aren't solvent - and then proceed to restructure them (never using the N word). Congress might sensibly instruct the administration to do just that. Otherwise, another trillion or so will be devoted to keeping the zombies alive, while the economy -- and the Obama presidency -- suffer.

But for this to happen, Obama will have to put grit in his policy, not just his rhetoric. As Steve Fraser recounts, in the last great depression, Franklin Roosevelt railed against the "money changers" from his first inaugural on, scouring them for squandering "other people's money, and promising to chase "these unscrupulous money changers" from their "high seats in the temples of American civilization."

But FDR combined bite with his bark. Again Fraser summarizes:

After 1929...new financial regulation was at the top of, and made up a hefty part of, Roosevelt's New Deal agenda during its first year. That included the Bank Holiday, the creation of the Federal Deposit Insurance Corporation, the passing of the Glass-Steagall Act, which separated commercial from investment banking (their prior cohabitation had been a prime incubator of financial hanky-panky during the Jazz Age of the previous decade), and the first Securities Act to monitor the stock exchange.

Over the past weeks, it is apparent that Obama has begun to educate Americans about the scope of the economic devastation that he must deal with. Now it is vital that his policies get as bold and radical as the crisis demands. The new banking plan isn't there.

From The Huffington Post, February 10, 2009.

Authors Website: http://www.ourfuture.org

Authors Bio:

Robert L. Borosage is the president of the Institute for America's Future and co-director of its sister organization, the Campaign for America's Future. The organizations were launched by 100 prominent Americans to challenge the rightward drift in U.S. politics, and to develop the policies, message and issue campaigns to help forge an enduring majority for progressive change in America. Most recently, Borosage spearheaded the Campaign's 2006 issues book, StraightTalk 2006, providing activists and candidates with distilled messages on kitchen table concerns, from jobs to affordable health care. Borosage also helped to found and chairs the Progressive Majority Political Action Committee, developing a national base of small donors and skilled activists. Progressive Majority recruits, staffs, and funds progressive candidates for political office.


Mr. Borosage writes widely on political, economic and national security issues for a range of publications including The Washington Post, the Los Angeles Times, and the Philadelphia Inquirer. He is a Contributing Editor at The Nation magazine, and a regular contributor to The American Prospect magazine. He is a frequent commentator on television and radio, including Fox Morning News, RadioNation, National Public Radio, C-SPAN and Pacifica Radio. He teaches on presidential power and national security as an adjunct professor at American University's Washington School of Law.


A graduate of Yale Law School, with a graduate degree in International Affairs from George Washington University, Borosage left the practice of law to found the Center for National Security Studies in 1974. The Center focused on the tension between civil rights and the national security powers and prerogatives of the executive branch. It played a leading role in the efforts to investigate the intelligence agencies in the 1970s, curb their abuses, and hold them accountable in the future. At the Center, he helped to write and edit two books, The CIA File and The Lawless State.


In 1979, Borosage became Director of the Institute for Policy Studies, a research institute that drew its inspiration and fellowship from the major democratic movements of our time -- anti-war, women's, environmental and civil rights movements. Borosage helped to found and guide Countdown 88, which succeeded in winning the congressional ban on covert action against Nicaragua. Under Borosage's direction, the Institute expanded its fellowship, launched a successful publications program, and developed a new Washington School for congressional aides and public interest advocates.


In 1988, Borosage left the Institute to serve as senior issues advisor to the presidential campaign of the Reverend Jesse Jackson. He traveled the country with Jackson, writing speeches, framing policy responses, and providing debate preparation and assistance. He went on to advise a range of progressive political campaigns, including those of Senator Carol Moseley-Braun, Barbara Boxer and Paul Wellstone. "