Memo To Obama: Banks Are Beautiful

In his search for what Theodore Roosevelt called ?a good, safe menace,? President Barack Obama has settled on the nation?s largest commercial banks, which as late as last year?s bailouts were still considered the best hope for economic salvation.

At first Obama was content to rail about the filthy lucre of banker bonuses. Then he got the idea of maybe hitting the bonus babies with special taxes. But the reason that the Secretary of the Treasury is often the former chairman of Goldman Sachs is because the bank is one of the instruments that keeps the government afloat.

Maybe President Obama didn?t get that memo, but he?s paying the banks? bonuses, and they are paying his. The President needs the American banking system much in the way that the banking system needs the government as its biggest client.

In his best imitation of William Jennings Bryant, who didn?t want the American experiment to be crucified on a ?cross of gold,? the President has proposed a populist uprising against the bankers, not to mention a restoration of the Glass-Steagall Act and a tax on bank assets to recoup the taxpayer money lost in the crash.

In attacking the money changers Obama would seem to be on safe ground. Who doesn?t despise an industry that got fat on mortgages and home equity, went bust, found redemption with easy government bailout money, and then celebrated by paying out bonuses from taxpayer contributions?

It?s easy to imagine the President leading a Million Man March into the temples of Citibank or Bank of America to demand penance for the wages of so many sins. The Democrats may have gotten Massachusetts all wrong, but how can they not benefit from igniting a few bonfires against the vanities of Wall Street?

The problem with a Banker Crusade is that once the ramparts are breached at castles like that of Goldman Sachs, what will become evident is that the entire American government can be understood as a failed S & L ? those savings banks of shame that in the 1980s found their vaults filling up with suspect asset pools, if not whitewater.

Like the government today, S & Ls lived beyond their means on other-people?s money, invested in bad assets, and resorted to phony accounting to cover up the losses? until the taxpayers were sent the bill for the overdrafts.

The root cause of the S & L crisis in the 1980s was the decision of the Reagan administration to deregulate savings banks (they were no longer limited to plain vanilla mortgages), but still allow them to keep their federal insurance for deposits up to $100,000.

Under this no-lose formula, banks could borrow nearly unlimited amounts of money in federally-insured deposits, and then lend out the funds to themselves, their cronies, or any get-rich-quick scheme that happened to send a prospectus to the bank?s board. S & Ls threw money at race horses, private planes, wine cellars, and even a few Senators, including John McCain.

When the borrowers went broke and the banks failed, the government bailed out the depositors, and the grubstakers moved on down the trail. As Warren Buffett quipped, ?In the 1980s, it was the bankers who were wearing the ski masks.?

In the end, the government paid out something like $500 billion to cover the depositors with federal insurance.

Fast forward to the U.S. government balance sheet in 2010, over which President Obama presides as the chief credit officer. As I read the annual report, the government is losing about $1.6 trillion a year, liabilities are $14 trillion and growing, and some of the nervous depositors are thinking of lining up at the front doors (or voting Republican).

The deposits funding the American dream come from government bonds and securities, some of which have been sold to overseas investors. Of the $14 trillion in liabilities on the balance sheet, more than $3 trillion is held abroad, much of it in Asia and especially China.

More troubling for the country?s Banker-in-Chief is that the government-as-bank ? instead of lending its borrowed money against hard assets such as railroads, schools, wharves, hospitals ? has put out the money to fund what the brochures might call Lifestyle Loans (?At American Security, you can live like there is no tomorrow?).

At least 1980s S & Ls had a few houses and planes to repossess. All the U.S. government now shows in its loan bags is a trillion-dollar budget deficit, off balance sheet liabilities (another $1 trillion) to pay for the wars in Iraq and Afghanistan, multi-trillion dollar obligations to the depositors of Fannie Mae and Freddie Mac, and the coupons (with a present value of about $41 trillion) awarded to its citizens for Medicaid, Medicare, and Social Security redemptions.

As a pyramid scheme, those numbers are hard to beat. The public debt is already equal to the gross domestic product, and government borrowings are projected by 2015 to rise to $20 trillion.

Lost in the presidential outrage against the commercial lenders is one reason why so many of them are flush with money, even in bad times: banks, notably investment banks, earn huge spreads brokering debt for the American government.

What put the government into the savings-bank business?

After 2001, when the economy stalled, the strategy to keep the good times rolling was to encourage lower margin requirements for investment banks, home mortgages, and consumers, who were patriotically encouraged to spend the equity in their homes at places like Wal-Mart. (?When the going gets tough, the tough go shopping.?)

To fund this asset bonanza (although it was based on dubious collateral), the government turned to the investment banks, which packaged, securitized, swapped, stripped, and laundered mortgage-backed securities until stock and real estate markets had doubled in value.

The bubble burst not just because of rapacious bankers, but in part because the government?s voracious need for funding dried up liquidity for the leveraged banks. To be sure, the likes of Lehman and A.I.G. had bad loans galore, but the financial crisis is also about an electronic run at banks competing with the government to find funding.

Ironically, banker greed pales in comparison to that of the U.S. Congress, which through the last decade pushed home ownership (thanks to the subprimers at Fannie and Freddie) as a way to spread the word of electoral happiness. Bad debtors got jumbo mortgages, and members of Congress got re-elected.

In the current market, Obama manages a balance sheet that looks a lot like Citibank?s: it limps along, based on federal guarantees, and most of the collateral (consisting of subprime mortgages and used B-52 bombers) has little resale value on eBay.

What bank would not want as its best customer a major industrial country that needs $14 trillion every year to balance its books?

One percent of $14 trillion is $140 billion, a figure that roughly equates to the annual income of the banks that President Obama is now threatening to penalize. Would he prefer that they stop rolling over government debt?

Listening to Obama rail against the banking fraternity, I can?t help but recall the high moral tone that starts the movie, Butch Cassidy and the Sundance Kid, which can be viewed as a cautionary tale on the moral hazards of (unauthorized) bank bonuses.

In the opening scene, Butch is casing out a bank that he is thinking about robbing. The guard signals to him that it?s closing time. Before leaving, Butch asks, ?What happened to the old bank? It was beautiful.?

The guard answers: ?People kept robbing it.?

To which Butch responds: ?Small price to pay for beauty.?

In time, that may become the President?s reconsidered view of the banker bonuses.

Matthew Stevenson is author of Remembering the Twentieth Century Limited and An April Across America.