From the New York Times:

Last June, with a financial hurricane gathering force, Treasury Secretary Henry M. Paulson Jr. convened the nation’s economic stewards for a brainstorming session. What emergency powers might the government want at its disposal to confront the crisis? he asked.

Timothy F. Geithner, who as president of the New York Federal Reserve Bank oversaw many of the nation’s most powerful financial institutions, stunned the group with the audacity of his answer. He proposed asking Congress to give the president broad power to guarantee all the debt in the banking system, according to two participants, including Michele A. Smith, then an assistant Treasury secretary.

Geithner’s proposal was quickly dismissed, but it highlights Geithner’s incredible loyalty to his banker friends and his desire to protect banks at all costs…to the taxpayer. (ht naked capitalism)

Ben Bernanke on Tuesday again warned that without improvement in the banking sector there can be no recovery.  Martin Wolfe in FT today, although arguing that the US has not yet become the new Russia, tends to agree with Simon Johnson that the bank oligarchy in the US must be broken up in order for the banking sector to improve and the economy to recover (we added the emphasis).

“[Prof. Johnson] argues that the refusal of powerful institutions to admit losses – aided and abetted by a government in thrall to the “money-changers” – may make it impossible to escape from the crisis. Moreover, since the US enjoys the privilege of being able to borrow in its own currency it is far easier for it than for mere emerging economies to paper over cracks, turning crisis into long-term economic malaise. So we have witnessed a series of improvisations or “deals” whose underlying aim is to rescue as much of the financial system as possible in as generous a way as policymakers think they can get away with.

I agree with the critique of the policies adopted so far. In the debate on the Financial Times’s economists’ forum on Treasury secretary Tim Geithner’s “public/private investment partnership”, the critics are right: if it works, it is because it is a non-transparent way of transferring taxpayer wealth to banks. But it is unlikely to fill the capital hole that the markets are, at present, ignoring, as Michael Pomerleano argues. Nor am I persuaded that the “stress tests” of bank capital under way will lead to action that fills the capital hole…

Yet decisive restructuring is indeed necessary. This is not because returning the economy to the debt-fuelled growth of recent years is either feasible or desirable. But two things must be achieved: first, the core financial institutions must become credibly solvent; and, second, no profit-seeking private institution can remain too big to fail. That is not capitalism, but socialism. That is one of the points on which the right and the left agree. They are right. Bankruptcy – and so losses for unsecured creditors – must be a part of any durable solution. Without that change, the resolution of this crisis can only be the harbinger of the next.”

We agree. But will the administration and congress forego the political contribution flow from the big banks to accomplish this necessity? It does not now seem likely. The socialism of too big to fail seems to be preferred by the powers that be – on both principle and political expediency.

Holman Jenkins of the WSJ says President Obama will never jeopardize his re-election by hurting the UAW:

“Even a “prepackaged” filing runs too much risk of a judge imposing more “sacrifice” on the UAW than the administration is prepared to tolerate.

GM bondholders understand this: They’ve been intransigent precisely because they calculate the UAW is too important to Democratic electoral politics for Mr. Obama to risk losing control of the reorganization process to a bankruptcy judge.”

What could be and what will be:

“Better than trying to rewrite GM’s business relationships — the job of a bankruptcy judge — Mr. Obama might take up the duties of a president. He might try giving the country a coherent auto policy for a change. He could repeal two fleets so Detroit could build its small cars profitably offshore and tame the UAW monopoly in the process. He could dump CAFE or impose a $5 gasoline tax so at least customers would have a reason to buy the cars Washington is forcing Detroit to build.

None of this will happen. Mr. Obama will be content with incoherent policies that poll well — which means GM, Chrysler and perhaps Ford eventually will need taxpayer subsidies as far as the eye can see — or until a real bankruptcy sometime after November 2012.”

Something tells us Mr. Holman is right about GM, so how beholding is Mr. Obama to the banks? Will there be pain for the banks, who have contributed vast sums to the president’s re-election, as well as to virtually all of Congress?  The answer seems obvious.  But will this approach backfire as a populist backlash starts against GM, AIG and the banks’ bailout bonanza?