Geithner and Bernanke on Banks

The Commerce Department reports today that January 2009 shipments of durable goods are down -17% year over year (Jan. 2009 versus Jan. 2008), and new orders down -26% year over year (yoy).

What does this have to do with Geithner (here and here) and Bernanke on banks?

A great deal.

For instance, computers shipments and new orders are down -30% and -27% yoy respectively, and non-defense capital goods ex-aircraft (goods like autos, appliances, computers, etc.) shipments and new orders are down -11% and -20% yoy. In short, consumers have pulled back in a major way, saving more instead of buying more. They are doing this in order to have something to retire on, since their home-equity wealth illusion has disappeared and the stock market appears to be offering less of a contribution to retirement security.

So while some recovery of demand is inevitable in time due to the need to replace old and broken items, a reduction in consumer need for credit to buy things like computers, new cars, bigger houses, appliances, etc. is evident and likely to be lasting. (This is similar to what happened in Japan, and needs addressing like this.)

In other words, even if the American economy stabilizes and grows moderately, America no longer needs as much growth in consumer credit as it has had in the past few years.

But this may not be a part of Geithner's and Bernanke's plans.

Normally, when there are too many companies providing a good or service to a market, some weaken and fail, and are either bought out by stronger companies or sold off piecemeal.

This has happened a few times with airlines, for instance.

For banks, this would likely mean further consolidation.

But in order to have more consolidation, we would have to allow weaker banks to fail so that they could be bought out by stronger banks or sold off in pieces to stronger banks.

The current plan being signaled by Geithner and Bernanke, though, appears to be to progressively provide capital over time to the existing major banks to keep them going, and to prevent any more of the major banks from failing.

For instance, if a major bank had even more losses, that would result only in additional capital being injected, and presumably a larger taxpayer ownership stake in the bank. (Note this bypasses the question of whether taxpayers should already have acquired a majority ownership of a certain major bank in return for their money to date. Also see Krugman on the Newshour here for another take on this.)

From Marketwatch on Bernanke before congress on Wednesday.

Bernanke spent much of the hearing on Wednesday trying to reinforce his message to Congress that the Fed and the Obama administration now have at least the outlines of a bank rescue plan in place that will show results over time and that banks are not on an out-of-control course to nationalization. [Hal here: "nationalization" would eventually result if taxpayers get ownership stakes in full return for their dollars, instead of only partial return.]

"The focus on nationalization kind of misses the point," Bernanke said.

While the federal government may acquire large minority positions in the nation's largest banks, it has no plans to run the institutions and zero out shareholders, Bernanke said.

"It may be the case that the government would have a substantial minority share in Citi (C) or other banks," Bernanke said. But the government has the tools already it needs "to make sure that banks just don't sit there," he said.

So in the judgment of Geithner and Bernanke, the thought appears to be that there has been enough consolidation of banks, and no more major banks should fail because this would be damaging to confidence.

They might be right -- perhaps enough banks have been consolidated that if a recovery ensues we'll have the right amount of banking capacity. They might be wrong -- it may be after the eventual recovery that there are too many banks, and consolidation will be inevitable. It may be that somehow general confidence would be better if a major bank was kept on life-support instead of being more seriously restructured or sold off. Or the opposite could be true.

At this point, this course of action allows for both possibilities -- keeping zombie banks on life-support, or in contrast truly fixing them. For instance, over time the Federal (taxpayer) stake in a major bank could eventually become so large as to amount to full or near full ownership, even at a diminished rate of exchange of stock for taxpayer dollars. And once such majority or near full ownership occurred, the bank might then be sold off in part to other banks, resulting in some consolidation.

But the words Geithner and Bernanke spoke suggest they feel it's better for general confidence to continue transferring more taxpayer dollars to existing shareholders in part (by accepting disproportionally small stakes in ratio to dollars injected) instead of having a more rapid nationalization of certain banks. That momentary confidence in the stock market is more important than other considerations, and that banks' further losses won't be that much, as the economy recovers.

It may be this view has to do with not wanting to recognize the American economy suffered the growth of a huge credit/debt bubble -- implying that past policies of the Fed permitted an actual bubble -- and that the current situation is therefore the collapse of a credit/debt bubble, instead of only a housing-led downturn.

This is how the Geithner/Bernanke plan appears at the moment, with the stress tests yet to be finished. And in fairness, plenty of decisions are yet to be made. The plan has a lot of room for flexibility. They might even make the best possible choices under their flexible parameters. These are the questions the coming months will answer.