Obama's Economic Hope Teeters at the Edge of a Chasm of Public Fear

Mort Zuckerman

First, we have the difficult task of saving and reconstructing a financial system in an atmosphere of resentment and deep distrust. The same financiers who preached the necessity of free markets on the way up have come to the public trough to be saved at a cost that will be in the trillions of dollars. Who can blame the average American taxpayer (who earns under $50,000 a year), who has to cope with broken hopes and diminished aspirations, not to speak of shattered expectations of a secure retirement, for becoming angry when he is asked to rescue institutions responsible for the chaos? When forced to fill the begging bowls of financial wizards, who then receive bonuses? But the institutional problems we face will not go away because we are enraged by the malefactors. The inescapable fact is that our financial system is the brains of a market economy that moves money from the people who have it to the people who need it for investment and economic growth.

National economic recovery and Wall Street's health are intertwined. As Federal Reserve Chairman Bernanke stated, "History demonstrates conclusively that a modern economy cannot grow if its financial system is not operating effectively." Former GE Chairman Jack Welch put it well when he said, "Healthy banks are to economies as healthy hearts are to people: They keep them alive with the 'lifeblood' of credit." Given our extreme dependency on credit, the patient is in cardiac arrest.

Not that the analogy will be easier to accept once the full scale of our predicament becomes clear. The estimated volume of bad loans that will have to be written off exceeds $2 trillion—and that is before write-offs estimated at $1.5 trillion from auto, credit card, corporate, and commercial real estate loans yet to be taken. Given that the total capital of the Federal Deposit Insurance Corp. banks is approximately $1.4 trillion, the U.S. banking system is essentially insolvent and may need as much as $2 trillion in new equity to fully resume its role. but we cannot allow the banks to fail. They provide organized, informational capital that understands the credit requirements between a borrower and a lender. Yet today, banks are wary that their capital can't survive most of the worst-case scenarios for the broader economy. This leads them to hoard much of their new capital against future losses rather than use it for loans, since they are unsure how many borrowers will default—or whether there will be more federal money to tap if large numbers do default. Under these circumstances, they simply cannot fulfill the credit-making function once offered by the now discredited securitization markets.

So credit remains very tight, and is even tightening more, in the midst of a harsh recession—the opposite of what is wanted or needed. Private behavior and the lack of confidence are neutralizing public policy. Having once had too little appreciation of risk, lenders now have too much. The willingness of lenders to lend and of borrowers to take on more debt, which is the basis for the creation of credit, is simply not there.

The Fed is basically taking charge of preventing a broad credit collapse. It is finding novel ways to lend to banks and guarantee their assets because the old ways are not working. It has cut the federal funds rate to 1 percent; it has increased dollar loans called "swaps" to other governments; it has made loans and provided credit in the billions and trillions of dollars to prop up financial institutions that may be too big to fail because their collapse would pose a systemic risk to our financial structure.

Understandably, the spectacle of huge amounts of taxpayer money being provided to these very institutions that contributed so much to our current financial difficulties has added to public distrust. The American people don't believe that taxpayer money is being used in ways that will benefit them. They are focused on one main thing: whether the economic measures sponsored by the new administration will halt and reverse job losses and stabilize home prices.