Creeping Nationalization

Obama's has shown that his approach to implementing unpopular policies is to avoid putting the measure up for public debate and congressional approval, de-legitimize his opponents and incrementally impose the policy.

In the case of immigration, Obama de-legitimized his opponents through the Homeland Security report that warned about "dangerous radicals who oppose undocumented immigration" and is implementing a de-facto amnesty though systematic non-enforcement.

In the case of banks, Obama started by demonizing"greedy executives," while avoiding a discussion on the largest culprits of our current economic crisis: the Federal Reserve, Fannie Mae and Freddie Mac. For the time being he cannot pursue an outright nationalization, so he instead is pursuing creeping, de-facto nationalizing of the financial sector by mandating their business practices. This explains why the Obama Administration has resisted having banks return TARP funds.

Even those who see the value in lowering executive compensation or having banks increase their investment in low income communities should be troubled that the federal government is mandating these goals. This is clearly part of the Obama Administration's raison d'être - to expand the state's role in every segment of economic and social life.

Banks Getting TARP Funds Pay The Price

By John Tamny,

Shares are down, and they're taking orders from government.

In the past week alone, readers of the business press have been treated to a variety of disturbing headlines concerning the federal government's role in the banking system. Subscribers to the Financial Times were greeted with "Treasury pushes Citi to cancel jet order."

From the Wall Street Journal readers found out that "On Street, New Reality on Pay Sets In." With regard to pay, Sen. Claire McCaskill is introducing legislation "that would limit the salary, bonuses and stock options of executives at financial companies getting federal bailout aid to no more than what the president earns." President Obama has since lent his voice to McCaskill's echo chamber with a plan to impose a $500,000 salary cap on executives with firms that accepted bailout money.

Notably, Bank of America (nyse: BAC - news - people ), a two-time recipient of Troubled Asset Relief Program funds, announced "a 10-year, $1.5 trillion community development lending and investing goal focused on delivering capital to low- to-moderate income and minority communities across the United States."

With the acceptance of TARP funds, apparently banks can no longer exclusively seek profits. They must use the money of depositors to forward the desires of a new and very intrusive shareholder: the federal government. The story about BofA follows news from a few weeks back that banks had dropped their opposition to a bill in the Senate that would give "strapped homeowners more leverage in renegotiating their mortgages."

While banks including Citigroup (nyse: C - news - people ) had once opposed the aforementioned measure, since the imposition of TARP, the "government is now keeping the company on a tight leash."

And what do some of the banks allegedly saved by TARP have to show for the government's investment? Citigroup is down 71% since it was introduced in October, while Bank of America is down 78%. J.P. Morgan, supposedly one of the healthy banks, is down a more pedestrian 33%.

Should any of this surprise us? Not really. As this column has noted before, government investment is never passive. With banks now serving their Washington masters, they can no longer think solely with profit in mind, nor can they invest in people or transportation without the federal government weighing in with its opinion.

So while the government will continue to expand its reach into the banking sector, this will surely come at the cost of the sector's true health. Capitalism will be the unfortunate loser owing to the certainty that bank operations will have less and less to do with returns on loans, and more and more to do with advancing all manner of social goals.

Very interestingly, the shares of San Antonio-based Frost Bank are down a mere 14.5% since TARP's introduction. Frost wisely chose to refuse TARP funds and, as a result, has been more able to narrowly pursue profits.

Indeed, contrary to the media-driven notion of a banking system in crisis, Frost recently reported near-record earnings for 2008. Having not fallen for the always-false God that is government aid, Frost is not hamstrung by the various encumbrances (see above) that go hand-in-hand with governmental largess.

Sadly, the story doesn't end there. Despite its excellent earnings, Frost (along with all other banks that refused funds) is still being weakened by TARP as though it had accepted money. With TARP's recipients more flush with cash than they might otherwise have been, Frost must compete in a lending environment distorted by the free money taken from the hapless taxpayer.
What will never be known is what Frost and other well-managed banks might have achieved absent TARP altogether. Also unknown is how much better off the banking system would be if healthy banks had simply been allowed to acquire poorly managed ones free of government oversight.

All of which brings us to the policy proposal du jour involving the creation of a "bad bank." Apparently unmoved by the disastrous imposition of TARP, banking "experts" in Washington now say the only way to generate more lending is for the federal government to borrow even more money in order to use it to buy the supposedly "toxic" assets on bank balance sheets.
Of course, if the government were to buy these assets at market prices, the banks selling them would effectively be made insolvent. This means the government will pay above the market rate in order to absolve flagging banks of poor lending decisions.

Worse, with the weak banks made somewhat whole thanks to government money, the healthy financial institutions will experience another body blow as they're forced to compete with "zombie" financial firms empowered by government aid.

While the Resolution Trust Corp. (RTC) of the early '90s doesn't strictly resemble the nascent "bad bank," it's easy to argue that memories of the RTC made this latest proposal inevitable. So long as the federal government continues to cushion banking crises, irresponsible lending will continue to birth new government entities meant to clean up messes made by unwise lenders.
If all of this weren't problematic enough, the fact remains that TARP recipients are already under the government's proverbial thumb thanks to TARP itself. The creation of a "bad bank" will put the banking system even more in hoc to Washington, and the long-term results promise to be ugly.

Conservatives made a lot of noise about the 1978 Community Reinvestment Act, and while surely an unfortunate bill, it will seem positively tame relative to what our federal minders dream up once their quasi-nationalization of the banking system is complete.

Going back to the early fall when TARP was still merely a concept, a lot of ink was spilled about how the economy would collapse absent the use of government money to fix the banks. Hysteria got the best of many then, and the result is a banking sector made weaker by the day.

With hindsight being 20/20, let's hope the saner among us realize that the only solution to the banking crisis is no solution. Only then will the profligate lose out to the prudent such that the prudent can start buying collapsed firms on the cheap, in order to rebuild the system altogether.
John Tamny is editor of RealClearMarkets, a senior economist with H.C. Wainwright Economics and a senior economic adviser to Toreador Research and Trading. He writes a weekly column for Forbes.