Is Obama Too Conservative?

[Sheilbh]

Obama's conservatism may not prove good enough

By Martin Wolf

Published: May 12 2009 19:56 | Last updated: May 12 2009 19:56



"If we want things to stay as they are, things will have to change." Thus wrote the Sicilian writer Giuseppe di Lampedusa, in The Leopard. This seems to me the guiding principle of the Obama presidency. To many Americans, he seems a flaming radical. To me, he is a pragmatic conservative, albeit one responding to extraordinary times. In his own way, Mr Obama is following the path trodden by Franklin Delano Roosevelt.

Nowhere is his conservatism more obvious than in the handling of the economic crisis. What we have seen unfolding, from the president's choice of Lawrence Summers and Tim Geithner as his principal policy advisers, to last week's "stress tests", is classic conservative policymaking. The aim is simply to get the show back on the road. As Mr Obama told The New York Times: "I'm absolutely committed to making sure that our financial system is stable." Stability is a quintessentially conservative aim. Many radicals on the right and left insist that undercapitalised banks should be recapitalised right now. But Mr Obama sees this as far too risky.

The results of the stress tests were a big step along the road the administration is taking. They impose enough pain to appear credible, but not enough to be disruptive. The 10 affected banks will easily raise the needed money: a total of $75bn (€55bn, £59bn). Their market valuations duly soared.

Douglas Elliott of the Brookings Institution has provided a comparative analysis of how the US regulators reached their conclusions.* He contrasts their numbers with those of the International Monetary Fund, in its latest Global Financial Stability Report, and Nouriel Roubini of RGE Monitor and New York University. He also allows for the fact that the IMF and Mr Roubini look at all losses in US banking, while the tests apply to 19 institutions that hold some 70 per cent of US banking assets.

Estimated losses for 2009 and 2010 by the US regulators, the IMF and Mr Roubini are $535bn, $321bn and $811bn, respectively. So regulators were noticeably more risk-aware than the IMF, albeit less so than Mr Roubini. Against these losses are set the expected earnings (after dividends) over these years, plus a provision for 2011 losses. Here the regulators estimate earnings at $363bn, against an assumed $210bn for the IMF and Mr Roubini. This means the reduction in capital is estimated at $172bn by the regulators, $111bn by the IMF and $601bn by Mr Roubini. But, after allowing for planned capital-raising and excess earnings in the first quarter of 2009, the final reduction in capital is just $62bn for the regulators and a mere $1bn for the IMF, but as much as $491bn for Mr Roubini.

There are two important numbers in the above analysis: possible losses, and the buoyancy of earnings. Yet there is a final number of no less significance: how much capital does a bank need? The answer is: how long is a piece of string? Since many of these banks are deemed too big to fail, taxpayers are risk-bearers of last resort. The capital requirement depends partly on how well the government wants to be cushioned against possible losses and partly on how well bond-holders want to be insured against the possibility that government might refuse a rescue.



At the end of 2008, the ratio of total common equity to US banking assets was 3.7 per cent. Without the explicit and implicit insurance provided by government, it would surely have been higher. As the IMF notes, in the mid-1990s, before the leverage boom, the ratio was 6 per cent. In the 19th century, before deposit insurance, it was much higher still.

The conclusions are three: first, the government's exercise is more conservative on losses than that of the IMF, albeit far less so than Mr Roubini's; second, most of the capital to be raised will come from the earnings of a banking system able to borrow on the favourable terms arranged by the central bank and then to lend more expensively to its customers; and third, the target capital ratios – Tier 1 risk-weighted capital of 6 per cent of assets and Tier 1 common equity capital of 4 per cent – are not especially onerous.

The purpose of the exercise was indeed conservative: to make it credible, though not certain, that the existing banking system and assets can survive the likely battering. This has been done well enough to satisfy the markets. But these banks will also be unable to expand their balance sheet significantly in the near future.

The biggest question is how far this exercise will help restore the economy. Commercial banks provide only a quarter of financial sector credit in the US, down from close to 40 per cent in the mid-1970s (see chart). Much of the rest came from various forms of securitisation. Unless and until the latter markets reopen fully, private sector credit is likely to be constrained. How far that constraint is binding depends on how far highly leveraged borrowers are willing to borrow, particularly when the collateral against which they borrow has lost value. For this reason, it is the huge stimulus – the least conservative parts of the economic package – that will deliver the recovery. These are also the least upsetting to the interests of powerful lobbies, particularly in finance.

More radical approaches – allowing more banks to default, for example – would have increased uncertainty in the short run and so undermined the return to stability Mr Obama craves. But here the president must reckon on a longer-term danger: that the rescued financial system will, in time, start to lay the foundations for another and possibly still bigger financial crisis in the years ahead.

Ensuring the rescue of a financial system packed even more than before with complex and "too-big-to-fail" institutions may well be the cautious response to this crisis. But it leaves the government with the even more onerous task of imposing effective regulation in future. Unhappily, the record of regulation of generously insured financial systems is extremely poor. The mobilised self-interest of highly rewarded players easily overwhelms the constraints imposed by far less well-rewarded and almost certainly less able regulators.

The more the crisis unfolds, the more evident it is that incentives in the financial system were (and are) badly distorted. I sympathise with the conservative approach to crises, but not if it leaves in place the plethora of perverse incentives that created them. At the end of this, then, there will be one big test: will the number of institutions thought "too big to fail" be as large as now and, if so, how will they be controlled? If the answers are still not clear, there will need to be yet more change.

*Implications of the Stress Tests, May 11 2009, www.brookings.edu
Write to [email protected]
More columns at www.ft.com/martinwolf

[Caliga]

"Logic clearly dictates that the needs of the many outweigh the needs of the few."

[DGuller]

I think he's more conservative than both sides expected him to be.  That's just fine by me.

[MadImmortalMan]

When I saw the headline, I thought the writer was going to be a batshit insane-type. But then I realized he was only talking about the banking stuff.

[CountDeMoney]

As far as oversight is concerned, the SEC should be brought under the FBI.

[KRonn]

Is Pres Obama too conservative like some of his supporters claim, or a flaming socialist like some of his opposition claims?   

[Neil]

As far as oversight is concerned, the SEC should be brought under the FBI.

I thought you hated those guys?

[Berkut]

I think he's more conservative than both sides expected him to be.  That's just fine by me.

I think he is just a smart guy who knows (and probably always knew) that governance is not about the extremes. Running against Bush though, he had to appeal to the frothing crazy Moveonistas, so he sounded a lot more frothing crazy than he really was - and now those same *real* frothing nutjob liberals are getting pissed he isn't really all the nutty. He is a reasonable, practical guy.

He is by no means Conservative though. He is a reasonable, rational, practical liberal, and leans rather socialist.

[Admiral Yi]

He is by no means Conservative though.

He's easily as conservative as FDR.

[derspiess]

What a silly article.  So supporting a stable financial system is all you have to do to be a conservative these days?

[KRonn]

What a silly article.  So supporting a stable financial system is all you have to do to be a conservative these days?

Yeah, seems good business/political policy direction, and not a left or right political issue. Though for people/groups who see the economic/financial collapse as ways to push through significant, or even more radical business change along the lines of their agenda perhaps, then something along the lines of staying the course (even with more regulations to prevent future such issues) would probably seem conservative.

[MadImmortalMan]

To be fair, there is a certain subset of Democrats would want to see Obama go all Allende on the US economy, and don't have enough of a sense of history to realize that would lead down the same path it did then. To them, nothing any reasonable President does will be enough.

[Sheilbh]

Yeah, seems good business/political policy direction, and not a left or right political issue. Though for people/groups who see the economic/financial collapse as ways to push through significant, or even more radical business change along the lines of their agenda perhaps, then something along the lines of staying the course (even with more regulations to prevent future such issues) would probably seem conservative.

Well Martin Wolf and the Financial Times are hardly radical.  What Wolf's suggesting is that if Obama's only goal is to stabilise the financial system and get it back to where it was - which is a conservative desire and is neither as radical as letting them collapse, or nationalisation, break-up and re-privatisation - then he could just be storing up trouble.  If we end this financial crisis with as many institutions that are too big to fail and without a change in the financial system (especially credit rating agencies and so on) then we're just waiting until the next time the government has to bail them all out.

What a silly article.  So supporting a stable financial system is all you have to do to be a conservative these days?

Yes.  The radical options would be to let the banks fall or root-and-branch reform.

Edit: Also Wolf is very worried that the deficit countries are basically being asked to stabilise the system and then start spending again which would be dangerous because consumer credit's likely to get tightened (personal debt relative to earning has tripled in the last couple of decades in the US, and even more in the UK), business spending's tough and the government won't necessarily be able to do much more.  The surplus countries - China, Germany and so on - need, in his view, to get spending up so that they help the ones in deficit recover.

[citizen k]

Roubini hates America.

[Habsburg]

OMG, Il Gattopardo is in my top 15 films evah!