Obama's Push For an Endgame to the Financial Crisis

Suddenly, Washington seems eager to prosecute banks and bail out homeowners.

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Funny what happens in an election year.

President Obama's first year in office was dominated by momentous economic decisions. The president rescued General Motors and Chrysler from oblivion and continued the aggressive bank bailout program started by his predecessor. The Federal Reserve administered economic shock therapy, including its first "quantitative easing" program. Congress passed a huge and controversial stimulus plan, along with smaller measures meant to arrest the plunge in home prices and temporarily boost car sales.

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As Obama runs for re-election, he can plausibly argue that taken as a whole, those efforts helped prevent a depression and get a reeling economy back on its feet. Deep problems remain, and economists will argue for years over the effectiveness of various programs. But the economy is growing again, there's modest hiring, and a rising stock market suggests that investors are more optimistic about the future.

There's still a lot of unfinished business from the early days of the financial crisis, however, and there's been a sudden burst of activity that seems designed to bring some of that to a close. Maybe it's just a coincidence that it's happening in an election year. But it would benefit Obama's re-election efforts if he could tell voters that he's finally addressed some of the lingering frustrations from Washington's extraordinary interventions in the economy. Such as:

A lack of prosecutions. Many Americans wonder how there could have been so much fraud in the mortgage business, so much lost money on Wall Street and so many bad decisions by government regulators--yet hardly anybody has gone to jail or even been prosecuted for wrongdoing. It's a complicated answer. Part of the problem is that it's not necessarily illegal to lose money or make bad decisions. In some cases it's hard to finger who exactly was responsible. gGvernment prosecutors are probably reluctant to bring cases if they're likely to be outgunned by armies of pricey corporate attorneys or embarrassed by a lack of convictions.

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But the government may finally be finding its backbone. The Securities and Exchange Commission, which so far has initiated a series of small investigations relating to the financial crisis, is now planning a much larger set of lawsuits, according to the Wall Street Journal. The SEC has apparently been looking into mortgage securities that were sold at the outset of the housing bust, when big Wall Street banks may have known that they were damaged merchandise but failed to inform buyers of those liabilities. Steep losses on those sorts of securities were one of the biggest contributors to the 2008 financial collapse, which led to the controversial bank bailouts.

If the SEC truly goes after prominent banks such as Citigroup, Bank of America, Wells Fargo and Goldman Sachs, it would be the most aggressive effort to date to hold somebody accountable for the financial meltdown that ended up costing taxpayers billions of dollars. There's almost no chance such suits would be resolved by Election Day, but they would allow Obama to claim that his administration is finally going after the Wall Street firms that many people believe wrecked the economy.

Bailouts for Wall Street but not Main Street. The idea behind the bank bailouts was that emergency resuscitation of the financial sector would ultimately benefit ordinary consumers through easier credit, which is essential for an economy to grow. That's actually been happening, as banks gradually repair badly damaged balance sheets and cautiously expand lending. But it's been way too slow to be convincing, and many people rightly wonder why the government bailed out bankers but seemingly abandoned ordinary taxpayers.

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Enter Plan G (or is it Plan H?) to help underwater homeowners. The recent $25 billion settlement between 49 states and several large banks over improper foreclosure practices is a victory of sorts for struggling borrowers who have been battling banks that themselves were beneficiaries of Washington's largesse. The money that will help homeowners is a pittance compared to the total amount that underwater homeowners owe on mortgages that exceed the value of their homes. But economists say it will help at the margins. The negotiations were started by states such as Florida and Arizona, but the feds promptly joined in, and Obama now claims that the settlement "will begin to turn the page on an era of recklessness that has left so much damage in its wake."

In addition, Obama has proposed another plan meant to help some underwater homeowners qualify for refinancing, which could shave $3,000 a year off the typical owner's mortgage payments. It would only apply to select borrowers, and it must be approved by Congress. So it might never happen, and even if it does, it may join a long list of preceding plans that have been marginally effective at best. Yet Obama has at least mustered a case that he's tried to bail out the little guy, after holding his nose while bailing out bankers.

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A pile of "toxic waste." Few may remember, but while backing the sale of Bear Stearns and the rescue of AIG in 2008, the Federal Reserve acquired a huge portfolio of "toxic" mortgage-related securities that were plunging in value, due to all the subprime loans bundled into them. The idea was for the Fed, with its infinite resources, to hold those securities until the storm passed and they could be sold once again in the normal markets, at prices that, at a minimum, would allow the Fed to break even.

That has been happening. The Fed's portfolio of securities acquired from Bear Stearns and AIG is less than half the size it was at the end of 2008. So far this year, the Fed has sold "toxic" securities with a face value of about $13 billion, in orderly auctions that suggest the market for such debt is healing. Other Fed programs remain controversial, but recouping the cost of two contentious bailouts will boost the Fed's credibility.

It will still take years for the long term effects of the financial crisis to play out, and some business will remain unfinished for a long time. The U.S. government still owns about one-third of General Motors, for instance, and GM shares would have to double in value for Washington to sell at a price that would allow it to break even. That seems very unlikely to happen this year, which means the government would have to sell at a loss if it wanted to unload its GM stake by the time of the November elections, or else hold the shares until it's a better time to sell.

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The Fannie Mae and Freddie Mac bailouts have cost taxpayers nearly $200 billion—making them the costliest bailouts, by far—and there's almost no chance that money will be paid back. Nor has anybody in Washington come up with a plan for what to do about the crippled mortgage giants. The housing bust at the core of the financial crisis, meanwhile, seems likely to continue through 2012, which will mark six consecutive years of steep price declines. At some point, it will all finally be over. But for now, the best Obama can hope for is convincing voters that some progress is good enough.

Rick Newman is the author of Rebounders: How Winners Pivot From Setback To Success, to be published in May. Follow him on Twitter: @rickjnewman

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