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Plan B

In June 2007, Tim Geithner, then the president of the New York Fed, gave a speech about the financial crisis he'd helped defuse as a Clinton Treasury official in the late 1990s. This particular crisis had originated in Asia rather than the United States, and it was triggered by international capital flows rather than a real-estate bust. But, in several important respects, it resembled the crisis we face today, which is why Geithner's thoughts on resolving it are so interesting.

Geithner referred to the approach he and his Treasury colleagues (among them Larry Summers, now the top White House economic adviser) adopted as a "Powell Doctrine applied to international finance--the overwhelming use of force, with a clear strategy for resolution." He elaborated: "Very substantial resources were deployed in support of the recovery efforts, and a large share of the resources was made available upfront, in order to try ... to stem the loss of confidence."

When Geithner's first major speech as Treasury secretary addressed our current financial crisis, many who'd followed his career wondered what had happened to the Powell-like principles. Sure, some of the rhetoric was similar--as when Geithner warned that "[t]here is more risk and greater cost in gradualism than in aggressive action." But, with Geithner's hazy details and pointed refusal to ask Congress for more money, little about the plan seemed "overwhelming."

Perhaps the boldest of the available options is temporary government ownership, loosely known as nationalization. Economists from Paul Krugman and Joe Stiglitz to Alan Greenspan have converged on this course, and the markets--or at least bank shareholders--are beginning to anticipate it. But Geithner has been even less keen on nationalization than the alternatives, telling Jim Lehrer it's "the wrong strategy for the country." Has the Treasury secretary suddenly lost his nerve?

Whether or not the banks are ultimately nationalized, they will clearly need more money. At the heart of the financial crisis is the gap between their liabilities and assets--the red ink overwhelms the black. Banks in this situation are loath to make new loans, without which businesses can't grow.

The main mechanism for providing money under the Geithner plan is a so-called "stress test," which will measure banks' tolerance for additional economic pain with the promise of cash for those too weak to withstand it. Thanks to the bank bailout Congress approved last fall, the administration still has between $200 billion and $300 billion available for this. But almost no one believes it will be enough to fill the existing hole. By failing to ask Congress for more money, the administration seemed to embrace precisely the gradualism Geithner cautioned against.

The administration clearly realizes this. As Obama noted in his speech to Congress this week, the bank plan "will require significant resources from the federal government--and, yes, probably more than we've already set aside." All things being equal, Geithner and Obama would almost certainly have asked for this money already. (The budget document that Obama released two days later has a $250-billion "placeholder" for additional bank money but repeatedly states that the administration isn't actually requesting the funds.) But, alas, this is where the parallel with the Asian financial crisis breaks down. Because while the ammunition deployed in that case came largely from the International Monetary Fund, which doesn't have to stand up at town-hall meetings in Schenectady to defend its disbursements, the Congress of the United States can only go so far before incurring the wrath of its Fox News-watching overlords.

And, in this case, the overlords have had enough. "[Members of Congress] are going back to their districts, home to their states, and they're getting an earful," explains one senior Democratic aide in the Senate. "A lot of guys came back from recess last week, and the right wing had done a good job stirring opposition." Asked about the prospect of more money for the banks, the aide said it would be highly unlikely, given the cumulative reaction to the first bank bailout, the stimulus, the auto-industry rescue, and Obama's recent housing plan. "'Bailout fatigue' is a term coined for this situation," the aide says. "I think that accurately reflects the view of the chairman of the banking committee, the chairman of House banking, of many within the caucus."

Which is why Geithner's goal with the bank plan may not have been to solve the crisis so much as demonstrate he could eventually be trusted with more money. Talk to administration officials these days, and you typically hear phrases like "show results" and "rebuild credibility"--language befitting a political crisis rather than an economic one. As Orin Kramer, a hedge fund manager and prominent Obama supporter, recently told me, "Until you establish credibility--that you are going to run a program with transparency and accountability, which isn't a gift shop--you cannot get additional financial authority from Congress." Obama's speech, with its tough talk about forcing banks to "demonstrate how taxpayer dollars result in more lending" and warning CEOs not to use "taxpayer money to pad their paychecks or buy fancy drapes," was aimed directly at this problem.

And here's where things get truly alarming: If Obama officials are able to "show results"--which most observers take to mean increased lending--then they probably won't need the money they'll be able to tap. But, if they're unable to show results, it will most likely have been for lack of money, which they'll have a hard time getting more of. It's a classic CATCH-22: The very reason you'd ask for help disqualifies you from receiving it.

Money aside, the question of nationalization poses serious complications of its own. Even defining the concept is maddeningly difficult. At the broadest level, it implies the government would own the banks and nurse them to health before presumably selling them off. What no one knows--and few people specify--is what ownership would mean as a practical matter. Would the government involve itself in day-to-day management? Would it wipe out current shareholders and own the banks entirely, or would it be satisfied with a majority stake? Would nationalization be more like temporary seizure--that is, honestly accounting for bad assets and injecting new capital, then privatizing as quickly as possible?

Whatever the details, Geithner and his colleagues are said to be deeply uncomfortable with the idea in principle. "Most people who run businesses in this area ... would look to nationalization as a last step--if it was the only thing standing between us and the abyss," says Michael Granoff, a private-equity fund manager who is friendly with several senior administration officials. "The people in charge of the economic policy side of things have pretty good communication with the people ... who sit where I sit," he says. "There is a shared understanding in these conversations."

Among the concerns is that government ownership invariably politicizes management decisions, which could be a fiasco (though the problems are presumably mitigated under a short-term arrangement). As TalkingPointsMemo recently reported, a coalition of unions is already lobbying against bailout money for The Principal Financial Group because of its campaign against labor-friendly card-check legislation. (Whatever the merits of card check, the debate is probably best separated from the banking crisis.) Many also worry that government ownership will frighten away large institutional clients who don't want the hassle, to say nothing of top managerial talent. A recent Wall Street Journal piece depicted Citigroup executives so harried by their government overseers that they worried about splurging for fresh-baked cookies at a corporate retreat.

On top of which, congressional Democrats are generally terrified by the prospect of becoming bank "nationalizers"--the GOP talking points practically write themselves. "It's the other N-word we're not allowed to say," complains another senior Democratic source. While it's true that Republican senators like Lindsey Graham have, in recent weeks, insisted the idea should be on the table, Democrats smell a rat. They believe Graham and his colleagues are out to spook the markets, forcing the Democrats' hand with self-fulfilling doomsaying. "These people say 'free markets,' 'leave everything alone,' 'let them fail,'" says the source. "Now, all of a sudden, they're saying, 'Nationalize the banks'? The cynicism is just incredible." Whether or not this scenario is plausible--and Graham certainly sounded sincere--it reflects very real anxieties on the Democratic side. (Graham's office did not return a call seeking comment.)

These concerns are all legitimate. And, yet, one can't help feeling we're headed inexorably toward nationalization anyway. Every new nationalization rumor sends stock prices tumbling (Citigroup recently hit an 18-year low and Bank of America a record low), forcing administration and Fed officials to coo reassurances. But, the lower the stock prices fall, the less likely private investors are to pony up more money--"If the stock is selling at ten dollars, private capital may or may not be willing to participate at $8.50," Kramer says; "if it's selling at four dollars, there's zero chance you'll participate at five dollars"--leaving government as the only option.

In many respects, the lurch toward nationalization has already begun. Treasury is asking for "convertible preferred" shares in return for the bailout money it gives banks. The preferred shares initially act like debt (which does not imply ownership). But they will be "converted" to common stock if a bank's balance sheet gets too out of whack. The process is now underway at Citigroup, for example, and is on track to leave the government with a massive 40 percent stake in the company. It's hard to see why Geithner's dictum wouldn't apply here, too: If you're going to nationalize, better to go big and bold at the outset, when the chances of success are highest, than to back into it unwillingly. But, alas, the politics appear to make this impossible.

The irony is that these two political constraints--no new money, no nationalization--could cancel out in theory. The public believes the same bankers who created the mess are now gorging at the federal trough. If nationalization were part of the equation, prompting managers and shareholders to scream about the expropriation of assets, the public might finally see its bloodlust satisfied and be willing to part with more cash. All the more so if Treasury argued that it represented a decisive final step, as opposed to the latest in a continuing drip of subsidies.

Then again, there's a fine line between pleasing everybody and pleasing nobody. Oh, to be a young Treasury official managing an Asian financial crisis.

Noam Scheiber is a senior editor at The New Republic.