As we all know, we have had an immense expansion of the role of government in the financial system. In the world after the crisis, what steps can we take toward reprivatization?
Let us consider four such steps.
Manage Tarp as a business. Having invested more than $300 billion in the capital of more than 600 financial companies, the Treasury Department's Troubled Asset Relief Program should make a reasonably paced, orderly withdrawal — perhaps taking three years or so.
The closest historical analogy to Tarp is the Reconstruction Finance Corp. of the 1930s. In a much more destructive financial and economic collapse, it invested in more than 6,000 banks, or 10 times the number of institutions involved in Tarp. The great majority of these investments eventually were retired in full, after paying dividends along the way, so that the RFC was able to show a modest profit.
The RFC was run by a forceful character named Jesse Jones. Jones was a conservative Texas Democrat, a tough-minded and successful entrepreneur who had dropped out of school after the eighth grade to enter business. "The program of putting capital into banks," he wrote, "was carried out without loss to the government or the taxpayer. On the contrary, it has shown profit through interest and dividends."
I believe the key to such a result is a business approach to managing the investments. The goal is for the managers of Tarp investments to act as fiduciaries for the taxpayers: to get their money back along with a reasonable overall profit. The predominant discipline should be that of investment management, not politics, while the Tarp portfolio is liquidated during the next few years.
Fix Fannie and Freddie. We have seen the effective nationalization of Fannie Mae and Freddie Mac. The equity the government continues to put in them looks likely to generate a loss of $100 billion to $200 billion, or more, for the taxpayers. The government, through the Federal Reserve, has also bought something on the order of $900 billion of Fannie and Freddie's mortgage-backed securities and debt.
Having government-sponsored enterprises with "implicit" government guarantees — which always were and now obviously are real guarantees — was a bad idea.
During the next two or three years, Fannie and Freddie each should be broken into three pieces: a dead-loss liquidating bank in receivership; for its future financial business, a truly private company competing in the marketplace like all other companies — succeed or fail, sink or swim; and for dispensing housing subsidies, a truly governmental entity, requiring congressional appropriations and merged into the Department of Housing and Urban Development.
No surviving part of Fannie or Freddie would be a GSE.
Put negative interest rates on excess reserves. The Federal Reserve's combined balance sheet has expanded to more than $2 trillion during the crisis — about two-and-a-half times its precrisis level. It now includes about $774 billion of mortgage-backed securities, $142 billion of agency debt and $65 billion of risky mortgage-backed securities and derivatives acquired from Bear Stearns and AIG.
In this sense, financing the crisis has made the Fed look more like a commercial bank. So does its great growth in deposits.
Risk-free deposits kept by banks at the Fed have grown to more than $1 trillion, about 65-times their precrisis level. Banks' holding of deposits at the Federal Reserve is the economic equivalent of their putting currency in the mattress, except that now the Fed is paying interest on these deposits. This means that banks can earn income simply by keeping a risk-free deposit with the Fed rather than having to lend or invest their excess reserves to earn a return.
Under current economic conditions, as we strive to reprivatize credit availability, excess reserves merely stuffed into the Fed mattress should have a negative interest rate, a cost for not lending or investing. It may sound odd, but it should be done.
Encourage new banks. In making good on its deposit guaranty, the Federal Deposit Insurance Corp. can itself come under financial pressure. The Federal Savings and Loan Insurance Corp. did not survive insolvency in the 1980s. The FDIC has announced that its liabilities exceed its assets by $8 billion as it faces hundreds more bank failures in the coming year or two.
Hence it has a strong incentive to force all new capital available to banking into solving the problem of failing banks, so new banking charters have become exceptionally difficult to obtain. From the perspective of the FDIC's problem, this is easy to understand.
But from a broader public policy perspective, the opposite approach would be better. As Randall Forsyth recently wrote in Barron's, "It's been the best of times for giant corporate borrowers storming the bond market but about the worst for small businesses dependent on bank loans."
Public policy should actively encourage new capital to form banks unencumbered by past losses, Tarp and nonperforming "bubble" loans — unencumbered, in other words, by the unfortunate past. These banks could get into the business of making private credit available to creditworthy enterprises and individuals.
Movement in the direction these ideas point toward would constitute measurable progress on a reprivatizing of the financial system.
