Obama's Wall Street Bank Rescue Stabilized Economy at a Political Cost

Photograph by Dennis Brack/Getty Images

When Barack Obama took office, the economy appeared to be on the brink of catastrophe. Despite the previous administrations commitment of several trillion dollars from every available arm of government to prop up the reeling financial system, nothing seemed to have worked. Banks were still hemorrhaging cash, and it was feared some would go down.

In his first weeks, the president was confronted with two courses of action. Some argued that as a consequence of disastrous mortgage investments, there was a good chance large chunks of the banking system were essentially insolvent. To prevent a collapse, the government had to take over some banks and restructure them, firing top management in the process.

The alternative view, embraced by Timothy Geithner, who was intimately involved in crafting the Bush bailouts, was that the U.S. banking system was in the throes of a gigantic, but essentially irrational, investor panic. Taking over banks and making an example of bankers would exacerbate an already fragile situation by spooking investors. The central imperative instead should be to restore confidence and reassure suppliers of capital by continuing to support the system.

Obamas political advisers urged him to go with the more radical policy. The Bush bailouts had been deeply unpopular, and the new president could appease some of the anger against bankers by going for something transformational.

The president chose to listen to his Treasury secretary and take the more cautious route. That meant avoiding a populist broadside against bankers, indeed deflecting outrage. Obama admitted as much when, at a meeting with bank chiefs in 2009, he said: I am all that stands between you and the pitchforks.

While Republicans often try to depict Obama as a radical, hes actually pragmatic and non-ideological. From an economic point of view, his decision to preserve the status quo proved to be the right strategy. Within a few months, the system stabilized and the cost of funds started to fall, enabling banks to recapitalize from private markets rather than rely on public money.

That success came at a high political price. In any panic, financial markets almost always overreact on the way down, requiring policymakers to correspondingly overreach in the level of support they provide. When all the measures eventually kicked in during the spring of 2009, they came to be seen as far too generous. That year, Wall Street came back from the dead, made spectacular profits, and rewarded itself with hefty bonuses. Allowing the bankers to profit so egregiously from the bailout weakened trust in government, compounded public cynicism, and fueled populist movements on the right and the left.

Ultimately, the presidents decision to allow bankers to get off lightly has to be understood in the context of his other ambitions, especially health-care reform. Unlike Franklin D. Roosevelt, who took office in the Great Depressions fourth year, Obama became president in the downturns early stages. He recognized he had to jettison other goals if he could not stave off an economic collapse. To do so, he had to save the financial system. Unfortunately it also meant saving bankers from the consequence of their folly and mismanagement.

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