Paul Krugman: The Big Squander

The economy needs more help from the government, but it's unlikely to get it:

The Big Squander, by Paul Krugman, Commentary, NYTimes: Earlier this week, the inspector general for the Troubled Asset Relief Program ... released his report on the 2008 rescue of the American International Group... The gist of the report is that government officials made no serious attempt to extract concessions from bankers, even though these bankers received huge benefits from the rescue. And more than money was lost. ...

Throughout the financial crisis key officials — most notably Timothy Geithner... — have shied away from doing anything that might rattle Wall Street. And ... this play-it-safe approach has ended up undermining prospects for economic recovery. For the job of fixing the broken economy is far from done — yet finishing the job has become nearly impossible now that the public has lost faith in the government’s efforts, viewing them as little more than handouts to the people who got us into this mess.

About the A.I.G. affair:... why protect bankers from the consequences of their errors? Well, by the time A.I.G.’s hollowness became apparent, the world financial system was on the edge of collapse and officials judged — probably correctly — that letting A.I.G. go bankrupt would push the financial system over that edge. So A.I.G. was effectively nationalized; its promises became taxpayer liabilities.

But was there any way to limit those liabilities? After all, banks would have suffered huge losses if A.I.G. had been allowed to fail. So it seemed only fair for them to bear part of the cost of the bailout... Indeed, the government asked them to do just that. But they said no — and that was the end of the story. Taxpayers ... ended up honoring foolish promises made by other people ... at 100 cents on the dollar.

Could things have been different? ... Major financial firms are a small club, with a shared interest in sustaining the system; ever since the days of J.P. Morgan, it has been common in times of crisis to call on the big players to forgo short-term profits for the industry’s common good. Back in 1998, it was a consortium of private bankers — not the government — that put up the funds to rescue the hedge fund Long Term Capital Management.

Furthermore, big financial firms ... can pay a price if they act selfishly in times of crisis. Bear Stearns ... earned itself a lot of ill will by refusing to participate in that 1998 rescue, and it’s widely believed that this ill will played a major factor in the demise of Bear Stearns itself, 10 years later.

So officials could have called on bankers to offer a better deal,... and simultaneously threatened to name and shame those who balked. It was their choice not to do that...

And, as I said, these seemingly safe choices have now placed the economy in grave danger.

For the economy is still in deep trouble and needs much more government help. Unemployment is in double-digits; we desperately need more government spending on job creation. Banks are still weak, and credit is still tight; we desperately need more government aid to the financial sector. But try to talk to an ordinary voter about this, and the response you’re likely to get is: “No way. All they’ll do is hand out more money to Wall Street.”

So here’s the real tragedy of the botched bailout: Government officials, perhaps influenced by spending too much time with bankers, forgot that if you want to govern effectively you have retain the trust of the people. And by treating the financial industry — which got us into this mess in the first place — with kid gloves, they have squandered that trust.