I don't generally overreact to news (from the NYT this morning, on the AIG-Goldman connection that runs through Edward Liddy's stock ownership), but this has gone far enough.

Have we completely lost of sense of what is and is not a conflict of interest? Have we really built a system in which greed fully overshadows responsibility? Is it not time for a complete rethink of what constitutes acceptable executive behavior?

One of our country's leading corporate attorneys made a telling point to me on Wednesday night, "the only way to control executive behavior is to criminalize it," i.e., civil penalties do not change behavior - the prospect of jail time has to be on the table. His broader point was that antitrust action can make a difference in today's world, but only if this includes potential criminal charges.

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With our myriad banking problems, rapidly rising unemployment, looming political battles over the budget and much more on the pressing domestic agenda, is the G20 summit in London (dinner Wednesday and meeting Thursday) really worth all the time and effort that the President and his team have devoted to it? And, granted that President Obama has to attend this heads of government meeting for protocol reasons, is there much that this summit can realistically achieve - i.e., are there actions that will be taken as a result of the summit that would not otherwise have happened and that can really make a difference to the parlous state of our economy?

These are all reasonable questions. And the answer is simple: in terms of the obvious major issues of the day, this summit is unlikely to achieve much.

But every global economic recovery has to start somewhere and it probably has to begin small. And there are some slight glimmers of hope because (a) President Obama is taking a global leadership role, (b) he is doing this in a creative way that might seem surprising, but which should reduce the chance of a further global meltdown.

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Stabilization programs in emerging markets often come down to this: the government needs to do something unpopular, e.g., reduce some subsidies, privatize an industry, or eliminate the crazy credit that goes to oligarchs - no one likes oligarchs, but their factories employ a lot of people. There is naturally resistance - pushback from legislators, riots in the streets, or oligarchs calling their friends in the US foreign policy establishment. The question becomes: does the government have the "political will" to get the job done?

In fall 1997, a key issue for Indonesia's IMF program was whether the government could close the banking operations belonging to one of President Suharto's sons. There was an epic and fascinating struggle and, in the end, the government did not have sufficient political will or power. The subsequent loss of US support, and further currency and economic collapse is (messy and painful for many) history.

It is striking that Ben Bernanke now asks whether the United States today has sufficient political will.

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If you've worked on economic policy formulation - or in any large bureaucracy - you know how to get your boss to make the decision you want. The key is to frame the options in such a way that he or she feels that your preferred course of action is the only plausible direction. Alternatives need to be undermined or discredited.

Smart bosses know this, of course, and they seek out sources of information or analysis that are not managed by their subordinates. The problem is that, traditionally, most such sources are not sufficiently well informed, at a detailed level, to be really helpful in the decision-making process. The format of most mainstream media - 800 words for the general reader, 4 minute stories, etc - does not allow engagement at the technical level; and, to be honest, technocrats are very good at manipulating the information flow to even the best journalist (who is usually a generalist). And while there are always outside technical domain experts, research papers appear with a lag and op eds usually have a broad brush (again, a format constraint).

Seen in this context, President Obama - on the face of it - has the role of blogs exactly backwards. But perhaps he is instead telling us something more profound.

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Emerging market crises are marked by an increase in tunneling - i.e., borderline legal/illegal smuggling of value out of businesses. As time horizons become shorter, employees have less incentive to protect shareholder value and are more inclined to help out friends or prepare a soft exit for themselves.

Boris Fyodorov, the late Russian Minister of Finance who struggled for many years against corruption and the abuse of authority, could be blunt. Confusion helps the powerful, he argued. When there are complicated government bailout schemes, multiple exchange rates, or high inflation, it is very hard to keep track of market prices and to protect the value of firms. The result, if taken to an extreme, is looting: the collapse of banks, industrial firms, and other entities because the insiders take the money (or other valuables) and run.

This is the prospect now faced by the United States.

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I like the general tone - reassuring but conveying the seriousness of our situation. My guess is that the daily consumer spending numbers will be good tomorrow (unlike when George Bush tried to be reassuring on the economy in September 2008; consumption collapsed the morning after.)

But what exactly is the banking strategy? This is the critical piece that we haven't yet seen in meaningful detail.

Here's what the President just said,

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The modern bank robber calmly hands a note to the teller, asking for money and making a moderately specific scary threat. The robber, of course, expects the teller to hand over unmarked bills without a fuss.

This morning's "research" note from a major international bank is entitled, "Falling Short: The government needs to buy toxic assets," and the heart of their one page argument is, with the emphasis as in the original,

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The President's top political counselors face the following dilemma. They want to be tough on banks because that makes sense politically and, presumably, because it fits how they - with considerable relevant experience - would like to address the deeper underlying problems in the financial system.

But at least some prominent economic counselors to the President strongly disagree. The Treasury Secretary, in particular, articulates the view that being tough on the banks and top bankers would further worsen credit markets and thus deepen/prolong the recession. Mr Geithner wants to try other routes, and while he does not rule out imposing policies that banks would not like, it is not in his Plan A or likely a feature of his Plan B.

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When you cut through the technical details and the marketing distractions, sorting out the US banking fiasco comes down to one, and only one, question. How tough are you willing to be on the people who control the country's large banks?

One option is to be gentle with them and adopt only ideas that they pre-approve. This route involves complicated schemes to purchase, lend against, or otherwise "wash" toxic assets out of the banks using taxpayer subsidies. This will be expensive (for the taxpayer), will be messy politically, and - most likely - will not work, in the sense of restoring the banking system to something close to its normal mode of functioning; check with Hank Paulson for details.

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At 11am this morning, from the Cash Room at the Treasury, Secretary Geithner will lay out his vision (and hopefully some convincing details) regarding how to get the US financial system back on its feet. What should we listen for as indications that this is heading in the right direction?

1) If there is a "once and for all" audit of the banking system, as President Obama seemed to say yesterday, what do we learn about the toughness of the rules under which this will be conducted? Annoucing an thorough assessment is potentially a positive step, but vagueness spells trouble (for us, not the banks) down the road. We need this audit to force major banks to use market prices to mark down fully their portfolios; anything else is evasion and procrastination.

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There comes a time in every economic crisis or, more specifically, in every struggle to recover from a crisis, when someone steps up to the podium to promise the policies that - they say - will deliver you back to growth. The person has political support, a strong track record, and every incentive to enter the history books. But one nagging question remains.

Can this person, your new economic strategist, really break with the vested elites that got you into this much trouble? The form of these vested interests, of course, varies substantially across situations, but they are always still strong, despite the downward spiral which they did so much to bring about. And fully escaping the grip of crisis really means breaking their power.

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Here's what we know so far about the plans for the US banking system that Tim Geithner will unveil next week.

1. The heart of the scheme will, most likely, be an insurance arrangement, in which the government (part Treasury and mostly Fed) insures a big part of large banks' portfolio of toxic assets against further loss. The devil is in the pricing of this insurance and how transparent that is - and we will put out more on this shortly - but the clear signal so far is that this will be a veiled major recapitalization of banks at taxpayer expense.


2. As announced yesterday, the government will set restrictions on the pay of executives in banks that participate. But note that, under these rules, bonuses are not restricted. Instead, they are just deferred and paid in shares. In other words, if there is cheap recapitalization through government-provided insurance, these executives are getting an incredibly good deal.

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According to David Leonhardt, writing in today's New York Times magazine,

TWO WEEKS AFTER THE ELECTION, Rahm Emanuel, Obama's chief of staff, appeared before an audience of business executives and laid out an idea that Lawrence H. Summers, Obama's top economic adviser, later described to me as Rahm's Doctrine. "You never want a serious crisis to go to waste," Emanuel said. "What I mean by that is that it's an opportunity to do things you could not do before." (Links in the quote are from the on-line original.)

Leonhardt explains how this Doctrine can be applied to issues ranging from health care costs to education, and some of this is already apparent in the fiscal stimulus details currently before Congress.

Can the same approach also guide actions regarding our deeply broken and broke financial system? There are three possible answers.

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According to David Leonhardt, writing in today's New York Times magazine,

TWO WEEKS AFTER THE ELECTION, Rahm Emanuel, Obama's chief of staff, appeared before an audience of business executives and laid out an idea that Lawrence H. Summers, Obama's top economic adviser, later described to me as Rahm's Doctrine. "You never want a serious crisis to go to waste," Emanuel said. "What I mean by that is that it's an opportunity to do things you could not do before." (Links in the quote are from the on-line original.)

Leonhardt explains how this Doctrine can be applied to issues ranging from health care costs to education, and some of this is already apparent in the fiscal stimulus details currently before Congress. 

Can the same approach also guide actions regarding our deeply broken and broke financial system?  There are three possible answers.

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The big annual economic meeting at Davos opens next week (Jan 28-Feb 1 are the official dates), and the discussion there - in both formal and informal interactions - is worth scouring for indications of the current situation around the world and where we all may be heading.

Given the likely composition of the main players this year - world corporate leaders and the non-US policy elite (with the new US policymakers stuck in Washington, doing real work) - I would suggest viewers at home and on the ground keep watch for answers to the following.

Are we on the same planet? It is not unheard of for Davos participants to appear as if they are living in their own bubble (in more sense than one). Watch for opulent parties and excessive consumption, particularly if the people involved have nominated themselves for any kind of government handout. If you meet someone from Merrill, ask if their attendance fees came out of 4th quarter earnings - or if there is still more bad news to come.

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