Obama's first crisis: dud banks

The new financial crisis will take hard choices, but the goal must be restoring trust.

In his inaugural, Barack Obama spoke of past failures "to make hard choices." Now he must make one – and fast. Since Jan. 2, the nation's four largest banks have lost half their value. On his first day as president, financial firms fell 15 percent. As FDR did in his early days in office, Mr. Obama must move quickly to replace panic with trust in US banks.

His hardest choice is how to cleanse banks of lousy loans – or "toxic assets" – notably mortgages given to people who put faith in ever-rising home prices. Somehow banks must be convinced to open their books to regulators and pluck out those dud loans. Only then can banks again be the main lubricators of a credit-based economy. Without that, Obama's stimulus package, aimed at creating 3 million jobs, won't be as effective.

His first task should be to soothe public fears about the government's sure hand on the banking system. Franklin Roosevelt tried to do that with his fireside radio chats. Obama can try the same, even on the Internet. (It doesn't help when he talks, as he did in his inaugural speech, of the economy's "raging storms.")

Beyond soothing talk, however, Obama must decide how much taxpayer money to put at risk. Under Bush, $1.5 trillion was injected into faltering institutions as shares or as insurance against potential losses. That worked to prevent a market meltdown last fall. But in recent weeks, the banks, having caused the recession with their lending excesses, were hit by the recession itself.

Now the choices are more dire.

One is to force banks to sell their bad mortgages at low prices to a government-supported bank, which will then sell them later when home prices perk up. After the 1980s savings-and-loan crisis, government did buy up bad assets and later sold them – at a profit. The fly in the ointment this time is how to price the loans fairly. Some banks may simply evaporate if the real value of their loans were known.

A second option is a takeover of banks, or nationalization, resulting in federal officials running private firms. That would subject taxpayers to the risk of huge bailouts – something government may simply not be able to afford.

Sweden, on a much smaller scale, did successfully take over troubled banks in the early 1990s. But the US crisis is on a multitrillion-dollar scale. To drive up the federal deficit too high could cause foreign investors to doubt US creditworthiness and flee. That could lead to a collapse of its currency. Britain faces such a crisis after intervention in its banks this week.

Another route – lowering the cost of each troubled mortgage with federal money – could take too long and be too messy to stem this crisis quickly.

Hard choices, indeed. Obama's economic team must hit the ground like gazelles. What they need to keep in mind is that, beyond the numbers, they are restoring a social virtue: trust. The recent breakdown in trust lies in a lack of transparency in financial institutions and the government's long role in encouraging homeownership without also controlling the inherent risks in such huge investments.

Lending in the US will resume once that vital social capital is restored. For right now, Americans are inclined to trust Obama to do just that.

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