I can think of very few reasons (none of them good) why Obama is so determined not to fix the actual problems in the banking industry. Economist James Galbraith spells out what needs to be done:
When the crisis went public in August 2007, Henry Paulson's Treasury took every step to prevent the final collapse from happening before the 2008 elections, extracting billions from the Federal Housing Authority and from Fannie Mae and Freddie Mac to relieve the pressure on bank balance sheets. It worked until it didn't. In September 2008 the collapse of Lehman triggered the collapse of American International Group (AIG) and the steps that led to the Troubled Assets Relief Program (TARP) and to the effective nationalization of the commercial paper market, meaning that the Federal Reserve has become the primary short-term funder of major American corporations.
Upon taking office, President Obama had a chance to change course and didn't take it. By seizing the largest problem banks, the government could have achieved clean audits, replaced top management, cured destructive compensation practices, shrunk a bloated industry, and cut the banks' lobbying power and therefore their capacity to obstruct financial reform. The way to write-downs of bad mortgage debt and therefore to financial recovery would have been opened.
None of this happened. Instead the Treasury administered fake "stress tests" and relaxed mark-to-market accounting rules for toxic assets which permitted the banks to defer losses and to continue to carry trash on their books at inflated values. This reassured the banks that they would not be permitted to fail—and so back to bonuses-as-usual they went. The banks survived, and the administration today claims this “proves” they didn’t need to be taken over. But to what end did they survive? The banks are bigger, more powerful, and more obstructionist than ever—and largely uninterested in making new commercial, industrial, or residential loans.
Today the former middle class is largely ruined: upside down on its mortgages and unable to add to its debts. With housing prices low and falling, banks are delaying foreclosures because they don't wish to recognize their losses; it is a sick fact that the cash homeowners conserve by non-payment is one source of the anemic recovery so far. But construction remains depressed, state and local budgets continue in a death-spiral of spending cuts and tax increases, the stimulus will soon end, and exports may soon fall victim to international austerity and the rapidly declining euro. Meanwhile the deficit hysterics seem determined to block unemployment insurance and aid to states today, and to cut Social Security and Medicare tomorrow.
In this way, the financial sector remains a fatal drag on the capacity for strong growth. And the financial reform bills about to clear Congress will not cure this. The bill in conference has some useful elements but it is neither sufficient nor necessary to clean up frauds, which have always been illegal. Nor will it clean up private balance sheets and permit lending to restart. Still less will it set a new direction for the financial economy going forward.
What to do? To restore the rule of law means first a rigorous audit of the banks and of the Federal Reserve. This means investigations—Representative Marcy Kaptur has proposed adding a thousand FBI agents to this task. It means criminal referrals from the Financial Crisis Inquiry Commission, from the regulators, from Congress, and from the new management of troubled banks as they clean house. It means indictments, prosecutions, convictions, and imprisonments. The model must be the clean-up of the Savings and Loans, less than 20 years ago, when a thousand industry insiders went to prison. Bankers must be made to feel the power of the law in their bones.
How will this help the economy? The first step toward health is realism. We must first stop pretending that bad assets can be made good, that bad loans will someday be repaid, and that bad people can run good banks. Debt crises are resolved when debts are written down and gotten rid of, when the institutions that peddled bad debts are restructured and reformed, and when the people who ran the great scams have been removed. Only then will private credit start to come back, but even then the result of bank reform is more prudent banks, by definition more conservative than what we've had.
So yesterday's borrow-like-there's-no-tomorrow America is done for in any event; there will not be another bank-sponsored private credit boom. The housing crisis (and therefore the middle-class insolvency) won't go away soon. There is no cure for falling housing prices except time and patience; debt relief will at best stabilize the middle class. It follows that the private banks and dealers and borrowing by households are not going to be at the center of the next expansion.
We are in the post-financial-crash. We need to do what the U.S. did during the New Deal, and what France, Japan, Korea, and almost every other successful case of post-crash (or postwar) reconstruction did when necessary. That is, we need to create new, policy-focused financial institutions like the Reconstruction Finance Corporation to take over the role that the banks and capital markets have abandoned. Thus, as part of the reconstruction of the system, we need a national infrastructure bank, an energy-and-environment bank, a new Home Owners Loan Corporation, and a Gulf Coast Reconstruction Authority modeled on the Tennessee Valley Authority. To begin with.
A reconstructed financial system should finance the reconstruction of the country. Public infrastructure. Energy security. Prevention and mitigation of climate change, including the retrofitting of millions of buildings. The refinancing of mortgages or conversion to rentals with “right-to-rent” provisions so that people can stay in their homes at reasonable rates. The cleanup and economic renovation of the Gulf Coast. All of this by loans made at low interest rates and for long terms, and supervised appropriately by real bankers prepared to stay on the job for decades.
The entire host of neglected priorities of the past 30 years should be on the agenda now. That is the way—and the effective path—toward prosperity.