Open Letter: Banking and Regulatory Capture

Dear Senators and Representatives,

I am writing today to express my frustration about the ongoing disaster that is the U.S. banking system. As I said in my previous letter of Sept. 23, “The rush to get [the bailout bill] passed is a scare tactic aimed at bullying Congress into passing something that favors Wall Street.” It was passed nonetheless and, unsurprisingly, did little to “calm” the markets. The reason is that the bailout bill did not address the fundamental problem: many of the country's banks are insolvent. Sec. Paulson's changing approaches to implementing the bill – first asset purchases, then cash infusions based on legislative intent, then back to asset purchases, and finally to complete disinterest – were counterproductive as well.

Unfortunately, the Obama administration to-date has not unveiled a better plan to rehabilitate the banking industry. The recent rumors about offering loan guarantees to private sector entities that buy the “toxic assets,” coupled with previous rumors about a “bad bank,” indicate that ultimately another TARP-like giveaway will be offered. The Obama administration continues to show signs of regulatory capture – meaning its thinking is guided primarily by the interests and assumptions of the industry, not the country at large. This is not surprising given that the core people appointed to handle the issue – Geithner, Summers, and Shapiro – all helped create the problem to varying degrees.

So it is now up to Congress to push the appropriate solution. In my previous letter I indicated that a bank rescue plan based on the “Swedish model” was the best approach, and that remains true. The fundamental steps are to 1) guarantee all liabilities (deposits, bonds) of all banks, 2) require the banks to re-value their assets (loans, other investments) either to market or to a very, very small-c conservative model, and 3) “nationalize” the insolvent banks with the goal of either consolidating them into solvent banks, or doing an public offering on the whole entity at some point in the near future. Essentially, it would be the FDIC process writ large, but with preemptive action. The goal is to make sure the banking system is not full of “zombies” – banks that are allowed to live on with poor capitalization and thus limited ability to lend. Japan experienced the effects of a paralyzed banking system during the 1990s, and that period is now referred to as the “Lost Decade.”

A key feature of a good plan is to make the irresponsible parties in the banks – senior management and shareholders, take the losses that should accrue to them. The TARP and other actions taken so far have been giveaways and are completely unacceptable. Shareholders failed to supervise the banks and should be wiped out. Additionally, I do not care about limiting the pay of current bank executives; I want them fired.

The country needs you to take action on the banking issue soon. Thank you for your time.