Pay Now or Pay More Later: What Can We Really Do about Toxic Assets?

For those of you who still think a “tarp” is something to cover up ugly debris, the government's TARP (Troubled Asset Relief Program) program actually does reflect the literal sense of the word quite well. Although the TARP has been an ever evolving work-in-process since it was first conceived by Hank Paulson in the last days of the Bush Administration, one aspect of it has not changed. TARP still represents the government's best efforts to help the financial industry contain a mountain of largely uncollectible debt. Yet months after the first attempts to bail out the banks, we still don't know just how toxic their "troubled assets" really are.

If you are wondering why the Feds and the Treasury and SuperObama can't just clean up the mess, it's worth taking the better part of an hour to listen to this week's public radio program, This American Life. NPR's Adam Davidson and TAL's Alex Blumberg have produced some of the best reporting to date on the banking crisis (See “Giant Pool of Money” and “Another Frightening Show about the Economy”.)

The most recent segment, “Bad Bank,” explains why we American taxpayers may have no choice but to pay “as much as we can” to redeem debts that bankers made to people with lousy credit and no credible means to pay back their loans. As a researcher from Deutsche Bank, Joe Lavorgna, wrote bluntly in a recent report: “Ultimately, the taxpayer will be on the hook one way or another, either through greatly diminished job prospects and/or significantly higher taxes down the line.” Mr. Lavorgna goes on to suggest that the government should "estimate the highest price it can pay for the various toxic assets on financial institution balance sheets," and then then cough up the funds even at taxpayer expense.("Taxpayer Beware: Bank Bailout Will Hurt").

If this sounds like a holdup note, both the reporters on this story and the economists and bankers they interview agree, it is. The banking industry after all its greed and excesses is basically telling us, “Pay up now, or just pay more later.”

But as one expert in banking crises from the Columbia University School of Business points out, this aspect of the financial crisis is not really new. According to Professor David Beim, history shows that governments have always bailed out the banks because societies can't function without them. He cites the example of a banking crisis in 37 AD that had the Roman emperor galloping back to the capital posthaste with bags of money to give to the bankers who had created the problem by making bad loans. Sound familiar?

Professor Beim notes that this has happened over and over and over again, only not on such a global scale. We'd be in great shape, relatively speaking, if the U.S. were merely Indonesia or Argentina. The IMF could intervene, take over the bad banks, clean things up, and the global economy would keep chugging along nicely. But take a behemoth like the United States with its Bank of America and Citigroup, which together hold over a quarter of all the money in the U.S. banking system, and we face a dilemma of a different order of magnitude.

The problem is compounded by the continuing belief that such dire outcomes “can't happen here” and by the anger of the American public who are still telling politicians to let the bankers take it on the chin even though it could propel the United States into a economic crisis that would make make the Great Depression pale by comparison.

Yet by far the scariest part of this reporting on the state of “bad banks” does not come from tales of people losing jobs or homes or life savings, but rather from a simple graph. According to David Beim, this is the hard data that shows we are not simply facing a housing crisis or a credit crisis but something much deeper and more systemic.

The graph shows that for much of postwar history, the collective debt of the American consumer has always been a mere fraction of our gross domestic product (GDP), usually hovering around 30%, sometimes rising to 50%, but in the last ten years, rising faster and until it reaches a point where the indebtedness of the American people equals GDP. That means 100% of what we owe is equal to 100% of all the goods and services we produce.

That has only happened twice in the last hundred years: in 1929 and now. As a nation we are literally out of room to borrow because we don't have the assets to borrow against. From this perspective, the problem of banks' toxic assets, intractable as it seems to be, is just the tip of the iceberg. We have all been victims of our own collective greed and our collective indifference to consumer borrowing run amuck.

So what can we do? Well, according to the experts we don't have many choices. Thanks to the fiscal irresponsibility of the past decade, we have a war we've borrowed to pay for, and a financial system that deregulation has helped send into a tailspin. And we, as consumers, have gone along for the “free” ride that is proving to be a costly fantasy trip.

We can pay now, or pay more later. And no amount of outrage or denial will change that.