Tuesday, July 24, 2012

Neil Barofsky: Wall Street gets bailed out, Main Street gets pummeled

In his Bloomberg column, former special inspector general for the TARP Neil Barofsky describes what happens when policymakers pursue the Japanese model for handling a bank solvency led financial crisis and protect bank book capital levels at all cost:

In the year since I stepped down as the special inspector general of the Troubled Asset Relief Program, the sadly predictable consequences of the government’s disparate treatment of Wall Street and Main Street have only become worse. As the banks amass size and power, Main Street continues to get pummeled.
Regular readers know that by protecting bank book capital levels and banker bonuses, policymakers are transferring onto the real economy the burden of supporting the excess debt in the financial system.

Supporting this excess debt requires the diversion of capital from re-investment in the real economy to re-payment of the excess debt.  The result is that growth in the real economy is stopped, in fact with a high enough excess debt level it is put into reverse.

Regular readers also know that a modern financial system is designed so that banks can protect the real economy from ever having to absorb the burden of repaying the excess debt.

With deposit guarantees and access to central bank funding, banks are designed to operate and continue to support the real economy even when they have negative book capital levels.  As a result, banks are designed to absorb the losses on the excess debt rather than putting the burden on the real economy.

With the ability to continue operating after absorbing the losses, the banks have the ability to rebuild their book capital levels.

I have called pursuing a policy of requiring the banks to recognize the losses on the excesses in the financial system today the Swedish model.

It was first successfully implemented in the US in the 1930s.  It has been successfully implemented on a number of other occasions including in Sweden in the 1990s and Iceland in 2008.

So the question is, what would it take to get the US policymakers to use the banking system as it is designed and protected the real economy?

Mr. Barofsky suggests

the loss of many Americans’ faith in their government -- may still yield a major benefit. 
The missteps by Treasury have produced a valuable byproduct: the widespread anger that may contain the only hope for meaningful reform. 
Americans should lose faith in their government. They should deplore the captured politicians and regulators who distributed tax dollars to the banks without insisting that they be accountable. 
The American people should be revolted by a financial system that rewards failure and protects those who drove it to the point of collapse and will undoubtedly do so again. 
Only with this appropriate and justified rage can we hope for the type of reform that will one day break our system free from the corrupting grasp of the megabanks.

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