President Obama said something very important and insightful during his address to Congress on February 24th. “We cannot afford to govern out of anger, or yield to the politics of the moment,” was the President’s advice on how Congress and his administration should proceed with stabilizing the financial system. The moral hazard involved in bailing out institutions deemed “too big to fail” is well documented, but the costs of allowing some financial institutions to fail is greater than the costs of using taxpayer dollars to stabilize these institutions. Both the administration and Congress must be wary of growing populist sentiment, because there will inevitably be more money needed to solve the financial crisis. Government leaders need to confront these issues head on and must be straight with the American people. There are some steps that can be taken in order to rally support for any necessary measures.
First, though, the fact that “too big to fail” institutions even exist is a problem and it is extremely unfortunate that these companies must be bailed out. The $160 million in retention bonuses that AIG recently paid is outrageous. AIG has now received over $180 billion in federal aid and has come to be known as the place where tax dollars go to die. Yes, the company is trying to wind-down its financial products division in an orderly fashion, but it still has over $1.5 trillion in derivatives on its books. There are plenty of other situations in which the taxpayer is seemingly getting a raw deal, and there is a lack of oversight surrounding bailout funds. As the President said, though, policy motivated by anger is ineffective.
A three-pronged plan must be set in motion by government leaders in order to sustain support for necessary interventions.
* First and foremost must be an explanation of why certain institutions are in fact “too big to fail.” Chairman Bernanke began to do this on his “60 Minutes” appearance. It is easy to dismiss some of these financial institutions as greedy and stupid, but they pose systemic risk. The failure of AIG is not in and of itself of tremendous concern. However, the failure of AIG would trigger losses by creditors and there would be a ripple effect throughout the economy. One need not look beyond the failure of Lehman and the seizures it caused in credit markets. The government must communicate the necessity of saving these institutions to market participants and the general public.
* Second, the administration must clarify their Financial Stability Plan. While details have been released, there are still many questions. Market participants are still hesitant to participate despite large subsidies because they fear ridicule and scrutiny from Congress. Questions regarding the subsidy that participants will receive as well as why certain proposed components were left out must be answered.
* Lastly, President Obama must continue to operate as a mediating force between the public outcry and the financial sector. The hard truth is that those who presided over the financial implosion are the ones who will be needed to salvage the sector. Also, many of the instruments and financial strategies that created many problems will be needed to pull us out of this.
The conundrum that President Obama faces comes down to the fact that the very people who are to be blamed are needed to repair their mess. Otherwise, bureaucrats could be elected to solve the nation’s problems and all would be well (alas, we know this doesn’t work). Obama must walk a fine line and this is why his message has seemed so inconsistent. However, outlining the need to support the financial markets rather than condemn them can go a long way in maintaining support for future financial stability plans.