Let big banks fail, bailout skeptics say

Top economists tell Congress the administration must change its approach to saving troubled financial firms or risk strangling an economic recovery.

EMAIL  |   PRINT  |   SHARE  |   RSS
 
google my aol my msn my yahoo! netvibes
Paste this link into your favorite RSS desktop reader
See all CNNMoney.com RSS FEEDS (close)
By Colin Barr, senior writer

carolyn_maloney_090316.03.jpg
A panel led by Rep. Carolyn Maloney, D-N.Y., was told huge financial firms must be broken up.
Which money-losing Fortune 500 company is most likely to turn a profit this year?
  • GM
  • Citigroup
  • Macy's
  • Ford

NEW YORK (Fortune) -- The Obama administration must break up the biggest financial firms if the nation is to return to economic health, three prominent bailout skeptics told a congressional panel Tuesday.

Columbia University professor Joseph Stiglitz and MIT professor Simon Johnson warned the Joint Economic Committee of Congress that the current government policy of propping up troubled financial giants could impede an economic recovery.

They each said spending taxpayer dollars freely on behalf of struggling big banks risks drowning U.S. productive capacity in debt -- while handing what amounts to an enormously costly subsidy to politically powerful financial sector insiders.

If the Obama administration fails to hold troubled banks accountable for their problems, the U.S. could face a lost decade of economic growth like Japan's in the 1990s, they said.

The third skeptic, Federal Reserve Bank of Kansas City President Thomas Hoenig, said policymakers must allow troubled firms to fail rather than propping them up, a la AIG (AIG, Fortune 500). He said banks must be treated consistently, regardless of their size or connections, for the sake of restoring confidence to markets and normal function to the economy.

"Rather than letting the market system objectively discipline the firms through failure and stockholder loss," Hoenig said of the current approach to bailouts, "we tend to micromanage the institutions and punish those within reach."

The hearing comes as Congress prepares to consider an Obama administration proposal to give regulators the authority to take over systemically important institutions. Treasury Secretary Tim Geithner has said such a plan is crucial if the U.S. is to avoid a recurrence of the current crisis.

Meanwhile, regulators led by the Treasury and the Federal Reserve are conducting so-called stress tests on 19 big banks, in an effort to demonstrate that the banks are well capitalized.

Big bank stocks have risen sharply over the past month, amid hope that government-subsidized lending and toxic-loan disposal programs will help restore the vitality of struggling financial institutions.

Shares of the most troubled banks -- Citigroup (C, Fortune 500) and Bank of America (BAC, Fortune 500), which together have received hundreds of billions of dollars of federal capital and asset-guarantee aid -- were among the biggest winners in that rally.

All three panelists said they believe the Bush and Obama administrations have misspent taxpayer funds in their zeal to stabilize the financial system -- and they warned that taxpayer money will continue to circle the drain if the Obama administration doesn't change course soon.

Along those lines, the International Monetary Fund estimated Tuesday that financial institution writedowns tied to toxic assets could reach $4 trillion globally.

Hoenig said authorities must set up a procedure that would allow big nonbank financial firms to be temporarily taken over by the government. Regulators would then replace management, wipe out shareholders and seek to sell the cleansed institution back into private ownership.

Stiglitz, formerly an aide in the Clinton administration, said the process of briefly taking over banks then selling them back to investors would be much less costly for taxpayers.

Both he and Johnson, a former IMF chief economist, added that the structure Hoenig sketched out would be good to have now - though it would have been better before last year's implosions at Bear Stearns and Lehman Brothers.

Instead, the government rescued Bear and let Lehman collapse - then got $700 billion from Congress that many argue was distributed willy-nilly to good and bad banks alike, as well as automakers and others.

The Lehman decision also froze credit markets and pushed AIG to the brink of insolvency. In response, the government extended an $85 billion emergency loan to the insurer. The cost of that rescue has since more than doubled.

The short-sighted responses to crises last year highlight the need to take bold steps now, Stiglitz said. "We really now ought to draw the line and say where we want to go from here," he said.  To top of page

Company Price Change % Change
Bank of America Corp... 16.15 0.00 0.00%
Facebook Inc 58.94 0.00 0.00%
General Electric Co 26.56 0.00 0.00%
Cisco Systems Inc 23.19 -0.02 -0.09%
Micron Technology In... 23.91 0.00 0.00%
Data as of Apr 17
Index Last Change % Change
Dow 16,408.54 -16.31 -0.10%
Nasdaq 4,095.52 9.29 0.23%
S&P 500 1,864.85 2.54 0.14%
Treasuries 2.72 0.08 3.19%
Data as of 6:16pm ET
More Galleries
50 years of the Ford Mustang Take a drive down memory lane with our favorite photos of the car through the years. More
Cool cars from the New York Auto Show These are some of the most interesting new models and concept vehicles from the Big Apple's car show. More
8 CEOs who took a pay cut in 2013 Median CEO pay inched up 9% in 2013 to $13.9 million. But not everyone got a bump last year. Here are eight CEOs who missed out. More
Sponsors
Worry about the hackers you don't know 
Crime syndicates and government organizations pose a much greater cyber threat than renegade hacker groups like Anonymous. Play
GE CEO: Bringing jobs back to the U.S. 
Jeff Immelt says the U.S. is a cost competitive market for advanced manufacturing and that GE is bringing jobs back from Mexico. Play
Hamster wheel and wedgie-powered transit 
Red Bull Creation challenges hackers and engineers to invent new modes of transportation. Play

Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer LIBOR Warning: Neither BBA Enterprises Limited, nor the BBA LIBOR Contributor Banks, nor Reuters, can be held liable for any irregularity or inaccuracy of BBA LIBOR. Disclaimer. Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.