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Too soon to let banks escape watchful eye of government

There's the president of the United States, sitting in the Cabinet room at the White House, talking with the heads of the country's biggest banks, each one of which had benefited from an extraordinary government effort to prevent the financial system from collapsing. The purpose of the meeting is to pressure banks to make more credit available to small businesses, to restructure mortgages rather than pushing them into default and to call off their lobbyists, who have been trying to water down the proposal to strengthen bank regulation.

At the same moment, officials next door at Treasury are putting the final touches on agreements that will dramatically reduce the leverage the administration holds over those very same banks by allowing them to repay the bailout money they received.

Hello? Is this what passes for political arm-twisting and bare-knuckle negotiation at the Obama White House? It's bad enough that the president's top priority of health reform was hijacked by a sanctimonious senator who can't seem to decide which side he's on. But in a capital where it is more important to be feared than loved, it's even worse for a president to tear into Wall Street "fat cats" one day and then let them off their leash the next.

By rushing to cash in their chips, the administration not only gave up political leverage and additional profit, but took the risk that one or more of the banks may find that it can't make it on its own. While the financial system has rebounded faster than anyone could have imagined, potential threats still loom — a further collapse of commercial real estate, for example. In other words, we're not out of the woods just yet.

Certainly the banks' requests to repay the government, all in the space of two weeks, look suspiciously like they were driven not so much by financial fundamentals as by the herd instincts that got them into trouble in the first place.

It's encouraging that banks have raised $160 billion this year on capital markets. But you'll pardon my skepticism if I note that it was the same markets that were throwing money at the same banks back during the bubble.

As to why investors may be so eager to put money into bank stocks, one need only consult Standard & Poor's evaluation of Bank of America's recent credit ranking. "We consider B of A to be highly systemically important and therefore continue to believe that B of A would receive extraordinary government support if necessary, though we do not believe such support will be needed," it said. In other words, they were bailed out once, they could be bailed out again.

Of course, S&P was wrong once before about Bank of America. The political reality is that, no matter how large, no bank will be bailed out again any time soon. The next time the government is forced to step in, that bank's shareholders will be wiped out, its executives sent packing and its operations wound down or sold off to competitors.

The rules governing this wind-down process are still being hammered out as part of the reform bill making its way through Congress. Until that legislation is signed into law, it would have been better to keep the banks right where they were, under the protective thumb of the government that rescued them.

Too soon to let banks escape watchful eye of government 12/20/09 [Last modified: Sunday, December 20, 2009 3:30am]
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