Crony capitalism has taken root in America

by Sin-ming Shaw

The Japan Times (May 19 2009)


For twenty years, Americans have denounced the "crony capitalism" of Third World countries, especially in Asia. But, just as those regions have been improving their public and corporate governance - Hong Kong just witnessed a breakthrough court decision against a telecom tycoon who is the son of the province's richest and most powerful man - crony capitalism is taking root in the United States, a country that the world long considered the gold standard of a level playing field in business.

The recently completed "stress tests" of US banks are but the latest indication that crony capitalists have now captured Washington. It is no surprise that stock markets liked the results of the tests that US Treasury Secretary Timothy Geithner administered to America's big banks, for the general outcome had been leaked weeks before. Indeed, most professional investors trashed the tests as dishonest even as their holdings benefited from a rising market. Even The Wall Street Journal, usually financial markets' loudest cheerleader, openly disparaged the tests' integrity. The government had allowed bankers to "negotiate" the results, like a student taking a final examination and then negotiating a grade.

The tests were supposed to reveal the true conditions of banks saddled with unaudited "'toxic assets" in housing loans and derivatives. The reasoning behind the tests seemed unimpeachable. But was it?

As any seasoned banker knows, a well-managed bank should undertake internal "stress tests" regularly as a matter of good housekeeping. The financial crisis should have mandated a running stress test to keep senior management up to date daily. Why, then, did the US need the government to conduct a financial exercise that bankers themselves could and should have done far better and faster?

The truth is that the tests were not designed to find answers. Both Wall Street's chieftains and the Obama administration already knew the truth. They knew that if the true conditions at many big banks were publicly revealed, many would have been immediately declared bankrupt, necessitating government receivership to stop a tsunami of bank runs.

But the Obama administration did not want to be tagged as "socialist" for nationalizing banks, however temporarily, even though experts such as former US Federal Reserve Chairman Paul Volker had recommended just that. Moreover, nationalizing banks would have required dismissing Wall Street captains and their boards for grossly mismanaging their firms.

Wall Street's titans, however, had convinced Obama and his team that their continued stewardship was essential to getting the world out of its crisis. They successfully portrayed themselves as victims of a firestorm, rather than as accessories to arson.

Geithner and Larry Summers, Obama's chief economic adviser, share Wall Street's culture as proteges of Robert Rubin, the former treasury secretary who went on to serve as a director and senior counselor at Citigroup. Neither man found it difficult to accept the bankers' absurd logic.

The stress tests were meant to signal to the public that there was no immediate threat of bank failures. This message, it was hoped, would stabilize the market so that prices for toxic assets could rise to a level at which bankers might feel comfortable selling them.

So far, Geithner seems to have succeeded in his tests, as the stock market has indeed more than stabilized, with prices of bank shares such as Citigroup and Bank of America quadrupling from their lows. The feared implosion of Wall Street seems to have been avoided. But no one ever seriously thought that the US would allow Citigroup and Bank of America, to name just two, to fail. Markets had already factored into share prices the belief that the US government would not allow any more banks to collapse.

What the world wanted was an accurate picture of what the banks were worth and "mark-to-market" valuations to guide investors as to how much new capital they needed. The world also wanted to see the US retaking the high road in reinforcing business ethics and integrity so lacking under the Bush administration.

As taxpayers had already put huge sums into rescuing failing banks, with the prospect of more to come, a transparent process to reveal how the money was being used was imperative. Substantial public rescue funds have reportedly been siphoned off to foreign banks, Goldman Sachs and staff bonuses for purposes unrelated to protecting public interests. None of this was either revealed or debunked by Geithner's tests. Instead, public servants now appear to be in cahoots with Wall Street to engineer an artificial aura of profitability.

Moreover, the value of toxic assets remains as murky as ever. Once-sacrosanct accounting principles have been amended at Wall Street's behest to allow banks to report essentially whatever they want. Now, negotiated stress test results have been released to "prove" that the banks are a lot healthier. Calling this a Ponzi scheme might be too harsh. Few financial professionals have been fooled.

Like swine flu, crony capitalism has migrated from corrupt Third World countries to America. Is it any wonder, then, that China is perceived as an increasingly credible model for much of the developing world?

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Sin-ming Shaw, a former founding chairman of a hedge fund and a private equity fund in Asia, has been a visiting scholar at Columbia, Harvard, Princeton and Oxford. He blogs at sinmingshaw.blogspot.com.

(c) 2009 Project Syndicate: www.project-syndicate.org

(c) The Japan Times. All rights reserved

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