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Obama's Exit Plan

No open-ended commitments to the financial sector.

During his election campaign, Barack Obama promised to withdraw all U.S. combat troops from Iraq within 16 months of taking office. "The days of our open-ended commitment must come to a close," he declared.

On inauguration day, January 20, the new U.S. president would do well to make a similar commitment to withdraw from another, equally fraught, arena: the nation’s financial sector. Obama ought to set a firm deadline to underscore his intentions and make clear that after that period, just as in Iraq, there will be no more open-ended commitments to banks and other financial entities.

The war on terror has cost upwards of $600 billion, an enormous sum that is nonetheless dwarfed by the multitrillion-dollar commitment in capital and guarantees that the U.S. has extended to the financial system. The price of defending Citigroup alone against collapse is some $350 billion.

It’s not just taxpayer money that’s at stake, but the long-term health of the financial world. Just as Obama argued in terms of Iraq, withdrawal, and the threat of withdrawal, will concentrate the minds of those most immediately affected: Banks will have to make hard decisions about their business models that with continued government assistance they could keep putting off. Government has a role to play, but allocating capital — which leads to the temptation to advance policy goals — risks dampening the innovation and entrepreneurship that drive U.S. growth. The incoming administration should commit itself to sweeping reforms, vigorous regulation and, above all, a date-certain retreat from the front lines of capitalism.

Certainly, the Bush administration had to move decisively to contain the crisis that accelerated in early September with the collapse of Lehman Brothers Holdings. But policy reversals and the improvisational nature of the bailouts have sown confusion and at times undermined the very confidence these extreme measures were meant to inspire. How does a massive bailout of Citi, just weeks after it was to rescue Wachovia Corp. with FDIC help, make Americans feel secure? And taxpayers’ sense of fairness is put to the test when they see Bank of America Corp., soon after receiving a $15 billion capital injection, invest $7 billion in a Chinese bank. How does that help free up lending in the U.S.?

As in Iraq the sense of crisis and panic in the financial world has temporarily abated. But it has been replaced by a paralyzing, near-existential dread that can be summed up in one question: Are we on the verge of another Great Depression? Or worse: Has one already begun?

None of this is Obama’s fault, of course, but it’s what his administration must contend with. Restoring confidence will require sound long-term planning, not just quick, seat-of-the-pants fixes. Taxpayers ought to ask the government something like what the government asked the automakers when they flew hat in hand to Washington in November for their bailout: What is your plan for the financial system, and how can we be sure the banks all have viable models going forward?

The good news is that after years of bellyaching and mutual name calling, the banks now find themselves more or less on a level playing field — or rather a leveled playing field. The Obama administration can use this ego-flattening crisis to lay out a farsighted framework for reforms, in areas like risk management and regulatory oversight, and commit itself to strict enforcement and policing. For one thing, it should encourage genuine transparency: It’s ironic to recall the old debate over the dangers posed by unregulated hedge funds in light of the recent insolvencies of highly regulated banks and investment banks. Perhaps taxpayers could use more information than can be gleaned from the traditional fan dance of regulatory discretion about the health of individual institutions.

The administration might summon the leaders of the financial industry to Washington to make arguments for their long-run viability. Telling them exactly when they can expect government aid to disappear ought to concentrate their minds. After all, never underestimate their willingness to be coddled and to fight from behind their mothers’ skirts.

The country needs confidence. We’ve seen the charity. Now we crave the faith and hope that are the new president’s stock-in-trade. Americans believed Obama on Iraq. Why should they doubt him on the economy?