Congress's Inquiry Into Financial Crisis Focuses on Wrong Target

Friday, July 17, 2009

HERE, MORE or less, is the state of the U.S. financial system as we enter the second half of 2009: The top 20 U.S. banks -- once thought to be insolvent and possibly in need of nationalization -- have survived a government stress test and begun raising private capital. The three-month London Interbank Offered Rate, which rises when banks are illiquid, has declined steadily since March. Several recipients of government bailout funds have repaid them. The Treasury Department felt confident enough of the system's soundness to deny further help this week to CIT Group, a previous recipient of bailout money.

All of this good news must be marked "tentative," of course, for the simple reason that the banks are floating on a sea of government-supplied liquidity, in the form of a near-zero Federal Reserve target rate, open-ended Treasury support to Fannie Mae and Freddie Mac, and multiple government credit guarantees. This is far from a self-sustaining recovery, and a new shock could push the system back to the brink. But all things considered, we could be doing much worse.

Under the circumstances, you might have thought Congress would hold a hearing about what has gone right so far and how to turn this incipient and vulnerable progress into something more permanent. Instead, we got yesterday's backward-looking affair at the House Committee on Oversight and Government Reform, the latest in a series of sessions aimed at December's federally engineered merger of Bank of America and Merrill Lynch, which has ended up costing taxpayers about $50 billion. Resentment of bailing out Wall Street is a bipartisan affair, so both Republicans and Democrats on this committee are determined to show how wrong it was for officials, including Federal Reserve Chairman Ben S. Bernanke, then-New York Fed boss Timothy F. Geithner and then-Treasury Secretary Henry M. Paulson to strong-arm Bank of America chief executive Kenneth D. Lewis into swallowing Merrill even after it turned out that the former Wall Street powerhouse faced much bigger losses than previously known.

In the witness chair yesterday, Mr. Paulson pretty much pleaded guilty to telling Mr. Lewis that he would be out of a job if he reneged -- with the explanation that the alternative would have been worse, namely a financial meltdown that would have spread around the world and probably cost taxpayers many billions more than did the Merrill-Bank of America merger or the bailout of insurance giant AIG. "By far the biggest advantage to the taxpayers is what didn't happen," Mr. Paulson said. Unsatisfied, several committee members arraigned Mr. Paulson for allegedly bailing out the banks and AIG to benefit his former Wall Street firm, Goldman Sachs. As proof, they cited Goldman's record profit of $3.4 billion in the second quarter.

Even though Mr. Paulson didn't quite dare to say it, Goldman's good quarter is a sign that he and other decision-makers made the right calls back in the scary fall and winter of 2008. The objective of government policy should be to get financial firms to where they are once again profitable without taxpayer support. It's absolutely true, as members of the committee said and as Mr. Paulson acknowledged, that the bailout of Wall Street is fraught with moral hazard: It broke the basic rule of capitalism, which says that business executives should bear all the costs of their bad decisions. But it's also true that financial stability is a public good. When the collapse of one or more financial institutions threatens to destroy financial stability, a government bailout can serve the public interest. Believing that, Mr. Paulson and his colleagues made some very difficult decisions under dangerous conditions. The ultimate results of those tough choices are still unknown. A fairer congressional inquiry, though, would start from the premise that, if he had not taken the actions that he did, the subject of today's investigations might have been a much, much bigger catastrophe.

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