This year's annual list of the top national news stories will not include the collapse of one or more big U.S. banks. Contrary to many a dire forecast in the first quarter of 2009, Bank of America, Citigroup and the rest pulled through. And they did so even though the government did not adopt any of the experts' most far-reaching recommendations -- such as nationalization and division into "good" and "bad" banks.
By year's end, in fact, Treasury Secretary Tim Geithner's plan for a "public-private partnership" to dispose of the banks' toxic assets, which was widely criticized as a half-measure, has proved mostly unnecessary because private investors stepped up without it. As Geithner recently testified to Congress, the 19 largest U.S. banks have raised more than $110 billion in common equity and other regulatory capital since he announced the results of a government "stress test" -- ridiculed as too tepid -- in May. That amount almost equals the $116 billion in repayments of bailout funds the Treasury has received from various banks. Current interbank lending rates are at or near levels consistent with financial normality.
So, all is well? Not quite. The fact remains that the big banks recovered their footing only thanks to immense government assistance, not all of which has ended. Though the Treasury bailout, known as the Troubled Assets Relief Program, has monopolized the headlines, the largest source of financial succor has been the Federal Reserve's vast expansion of liquidity: Banks got well in large part by borrowing hundreds of billions of dollars from the Fed at practically no interest and relending it to the Treasury at about 3 percent to finance the federal budget deficit. The Fed's huge purchases of mortgage-backed securities have also helped the banks by propping up the housing market.
This can't go on forever, and it won't: The Fed will stop buying mortgage-backed securities early next year and is widely expected to raise interest rates in the next 12 months or so to head off inflation. At some point, the banks are going to have to resume making money the old-fashioned way: lending to financially capable consumers and profitable, creditworthy businesses. Alas, there are too few of those these days, and it's not clear when, or whether, economic growth will generate the necessary level of good lending opportunities.
Most important, there is no clear answer to the ultimate question hanging over the financial system: Who, if anyone, is "too big to fail?" Indiscriminate government backing undermines the market discipline without which financial institutions cannot efficiently allocate capital. It can breed excessive risk-taking and endless bailouts. Yet to the extent the banks have survived this year at lower than expected cost, it is in large part because the market concluded that Washington would stand behind them, pretty much no matter what. This might be defensible as an emergency policy. It is no substitute for permanent reform.
