The Most Irrational Reaction To The Current Financial Panic…
…is to suddenly believe that the federal government, some $10 trillion in debt, is somehow doing us a favor by digging us into a bigger hole of debt. I have become quite vocal that government is making the current crisis far, far worse than it needs to be by bumbling around in a panic, scaring the hell out of everyone, and throwing money we don’t have at the problem of bad credit.
I have felt like, if not a voice in the wilderness, than at least a fish swimming against the tide, but I am not alone in believing that the same markets that are trembling so terribly right now are, yet and still, our only hope of salvation. Two op-eds in the Wall Stret Journal, still the most influential business publication in the world, provide much needed backing. First, Jonathan Macey, a law professor at Yale:
Despite all the hard work and good intentions on the part of our public officials, when economists and historians look back on the current financial crisis they are likely to conclude that government intervention prolonged and deepened it. In particular, officials at the Federal Reserve, the Securities and Exchange Commission and the Treasury Department are to blame for publicly losing confidence in the very economic system they are supposed to protect.
The Fed, the Treasury and the SEC appear to be in a state of panic. A crisis mentality led the custodians of the U.S. capital markets publicly to jettison their lifelong commitments to the capital markets in favor of a series of short-term regulatory quick fixes. Even more troubling, for the past several months the doyens of U.S. fiscal and monetary policy have ignored the most fundamental principle of central banking, which is that the primary responsibility of central bankers is to promote stability and to maintain confidence in the capital markets. Our central bankers appear to have suddenly lost confidence both in their own abilities and in the standard tools of fiscal and monetary policy.
The original Treasury plan — which called for the transfer of virtually unlimited taxpayer dollars and unlimited spending discretion to Treasury with no judicial or congressional oversight — sent a very bad signal to the markets. Instead of restoring confidence, this approach to the crisis instilled more fear and panic in the markets.
…The government also wrongly abandoned market solutions when it temporarily banned short-selling. Asserting that “unbridled short selling is contributing to the recent, sudden price declines in the securities of financial institutions unrelated to true price valuation,” the SEC temporarily forbade short-selling in financial institutions. The ban lasted from Sept. 17, until 11:59 p.m. Oct. 8, and was lifted only when the Treasury bailout was passed.
By the time the bailout package was passed, market sentiment had darkened to mirror the government’s own pessimism about the ability of markets to play a salutary role in repairing the fractured capital market. The notion that the government rather than the private sector can create a market for distressed bank assets seems particularly misguided.
…The Bear Stearns bailout, the restrictions on short-selling and the government’s new $700 billion commitment to buy toxic mortgage-based assets all share the same fundamental flaw: They prevent the market from imposing discipline on banks guilty of massive over-leveraging and excessive risk-taking. Moreover, they punish prudent managers who invested conservatively, kept their companies’ debt at reasonable levels and worked hard to raise new capital when necessary. The SEC’s attack on short-selling punishes savvy traders who invested resources and effort in identifying companies with too much debt and unrealistically valued assets.
Letting markets work is messy and costly. Nevertheless, the only sensible way to deal with the current crisis is to force the companies who created the mess to bear at least some of the costs of their mistakes. Most of all, if the markets are to get back on track our regulators must put an immediate stop to their current practice of publicly demonizing the markets and work to restore confidence in the system.
Next, the WSJ editorial board:
Amid economic fear and uncertainty, many Americans naturally look to government for reassurance. But with its vast power and potential to harm, government can itself become a source of panic. This has happened too often in recent days as Americans and the world have finally awakened to the scale of the losses in the banking system.
Let’s be perfectly blunt here: the Bush administration has failed, massively, in its handling of this crisis. Longtime readers know that I have been a fan of this administration (talk about swimming against the tide!), but economics is one of my two core issues (the other being national security, and of course, the two are not mutually exclusive). The failure has been both short-term and long-term.
Short-term, the Administration has fed a massive panic that has evaporated some $8 trillion in asset value so far, and we may not be through yet (that $8 trillion would almost, but not quite, pay our national debt). As Professor Macey points out, the government has failed in its most basic economic mission: promoting stability and confidence in our financial system and economic policies. The result is a decline in the markets that is already among the top four of all time, and the worst in 34 years, a decline that serves as a damning indictment of Bernanke and Paulson, and the Administration that acquiesced to their flailing demands.
But the short-term damage, as staggering as it is, pales in significance next to the long-term harm done to the ideas of free markets and capitalism. When our leading economic policy makers embrace socialistic solutions over market solutions, to the point of banning market solutions outright, as with the halt to short-selling, and promote government (government!) as the be-all and end-all solution to a crisis that government largely created, with its pressure on lenders to jettison due diligence and with its easy-credit, low-interest-rate monetary policy, then you can be sure the public, always suspicious of capitalism to begin with, particularly under the influence of today’s anti-globalist, know-nothing progressives, will be quick to run into the arms of Big Brother and away from the consequences of living beyond its means.
That this has taken place under a Republican administration is unforgivable, and the biggest tragedy of the many that we now face…
UPDATE 8:28 p.m.: In light of a comment made below, let me elaborate on the above assertion. I’m not putting party above country – I could care less about the Republican Party, per se, but rather I only care about what it has historically stood for, and one of those things has been the free market. In a world full of anti-globalist sentiment, and with a Democratic Party under the sway of protectionist, populist progressives, when the Republican Party abandons the free market, than the free market has basically lost its political base…
I feel that I must point out that my comment in your other post about “socializing” the financial markets was sarcastic. I completely agree with you in your disdain and demonizing of the government in this entire mess – it has failed miserably, most notably by getting involved in the first place. The more it tries to do, the more terrifically it fails. There is no real choice but to get out, to step back and let the market sort itself out. And, yes, Republicans, as embodied by this Administration, are very much to blame.
The biggest tragedy that we now face? Really? The biggest tragedy is the potential damage to your party’s brand?
The hogs on Wall Street and their foreign counterparts got greedy. Now they are being slaughtered.
The sacred markets failed already, before Paulson and the Fed did anything. No elected government can stand aside in such a situation.
Not the damage to the party, Fargus, the damage to the capitalistic market economy. The biggest boon to humankind has been the amazing advances in standards of living since the days of Adam Smith and the modern theory of free markets. Now, that legacy is being willingly given up by its most erstwhile standard bearers…I could care less about a Republican Party that doesn’t stand for the free market…but without the Republican Party to stand for it, who will? That’s my point…
The markets didn’t fail, Bob – in fact, the markets continue to respond to the signals received. Right now, the signals are of panicked government and worldwide depression, so they are tanking…my point is that government could mitigate this somewhat by keeping a cool head and trying to calm everyone down. That’s worth more, believe it or not, than a trillion dollars in government assistance…
The reason the Administration has done such a lousy job in managing this crisis, the reason they have been consistently behind the curve, is their reluctance (not their eagerness) to compromise on free-market ideology.
For too long, they insisted that the market would work things out, and no Government intervention was necessary.
Then, when it became clear that intervention was necessary, they proceeded, for too long, on a strategy-less ad-hoc basis.
* Opening up the Fed’s Discount Window to non-bank institutions? OK.
* Allowing bankruptcy judges to write down the principal on outstanding mortgages? Unthinkable!
* Bailing out AIG? Fine.
* Bailing out Lehman? Naw, let ‘em fail!
* …
Then, when it became clear that a comprehensive solution was necessary, they came up with the Paulson plan (or, more accurately, 3-page non-plan). Did it contain a provision (as everyone, from Chris Dodd on down, insisted) for the Government to take an equity position in firms helped by the bailout? No, because that would be socialist.
Fortunately, Dodd and Frank wrote the authority to do so into the final bill, anyway.
Because now, a little over a week later, they’ve come around to the realization that most economists have been advocating: taking an equity position in the troubled institutions is the quickest and most cost-effective way to recapitalize them. But. Paulson assures us, these will be non-voting shares. Good Lord, if the Government had the ability to kick out the executives who led these firms into the current mess, or the ability to ensure that the firms took the requisite steps to get credit moving again, why that would be socialism!
And we just can’t have that.
At every stage, they’ve been dragged, kicking and screaming, into taking the steps which would have calmed the markets, had they been taken weeks earlier.
I don’t know what sort of steps you think they should have taken. Certainly, there’s been more than enough speeches from the White House lawn. More happy talk would not have done the trick.
Heading off the problem in the first place, by moving in with aggressive regulations when the subprime mortgage market took off in 2003/2004, would have been the ideal solution, but was — shall we say — completely unthinkable.
I’ve never been much of a fan of the Editorial (or Op-Ed) page of the WSJ. But the rest of the paper is very, very, good.
And what does one find there? One finds articles like this.
Jacques, I could stand some of the steps they had taken, painful as they are for a free-market guy like me, had they shown any confidence in allowing them to work. But because they have thrown in everything including the kitchen sink, the only reasonable conclusion to draw is that they don’t know what they are doing
But you insist they should have nationalized the banking industry sooner. I’ll say this much for your position – by taking the equity stakes, at least the government has the POTENTIAL to come out ahead. But if the equity stakes in the banks were such a great deal, would private industry step in? I believe they would…but instead, we see Mitsubishi Financial backing away from the deal to invest in Morgan Stanley without EVEN MORE taxpayer largess to prop it up.
My points are two:
1. When you’re broke, you’re broke, and the American consumer, AND the American government, are broke. Even if massive government intervention is the preferred route of most (it sure ain’t mine), the inevitable question is, does the massive government intervention, coming on top of a $10 trillion debt load, push the United States itself into insolvency? As you’ve said elsewhere, if China comes to the conclusion that we cannot service our debt, we’re truly, totally, utterly screwed beyond redemption.
2. Forget the question of whether intervention on the scale envisioned is the right call for the moment – is it okay for the custodians of the United States economy to run around screaming that the sky is falling? Doesn’t that bother you in the slightest?…
And note also that Professor Macey (and the Wall Street Editorial Board) are not arguing against any government intervention. They are arguing against the loss of faith shown by policymakers in the wide range of tools they have at their disposal. The government intervenes in the markets all the time, using time-honored fiscal and monetary tools. True, this is an extraordinary time, and perhaps extraordinary measures are called for…but the measures employed should have been debated, passed without political blackmail, and given a chance to work.
I think every thinking adult knows what panic smells like – and Paulson and Bernanke reek of it…
One final point: I realize that we live in a system that has both capitalist and socialist tendencies. I realize, also, that perhaps, in truly distressed times such as these, purists must give ground to realists and we have to swing the pendulum a little closer to the socialist side.
But it’s the demonization of the markets that we see in so much of the rhetoric – from the left, and God help us, from the right – that is troubling to me.
Do you deny – and based on previous comments here, I’m pretty sure you don’t – that capitalism is one of the great goods to ever come to human society? We may wish to temper our capitalism with some socialism – but we don’t want to throw it away, do we?
Now, I know we’re not going Socialist here in America – but we are setting the cause of the global expansion of free markets back substantially, and ultimately, that is to the detriment of society globally…
We do agree on one thing, though – if government intervention was the call, it should have happened sooner, it should have been more comprehensive, and it should have broadly addressed the root causes rather than the ad-hoc reactions that you rightly decry…
Jeez, I keep coming up with one more ‘one more thing’s. I like the equity stakes better than the initial Paulson Plan, too – which, as you know, I strongly opposed from the very beginning. Why? Because the equity stakes show an inherent faith in the market to eventually right itself after the turbulence passes – if we didn’t think things would turn around, the stakes wouldn’t be any good…
The other big thing is, Will it work? If government buys an equity stake in an institution that has basically driven itself into insolvency, why am I supposed to be comforted that we bought a dog? Some institution are going to have to go down, and the market, ultimately, will be the final arbiter, regardless of how many trillions the government throws at the problem. Thomas Friedman today:
I think the fundamental difference between you and I on this issue is this: I think the problem is going to have to work itself out through the market, and as Friedman points out, when your company is basically worthless, the market is very cruel. I don’t see that adding 10-20% on to the massive federal debt is going to ultimately be a good idea, though there seems to be a strong impetus on the part of many, including yourself, to assume that the government can steer through this crisis without massive pain if it just chooses the right path.
My view is far more pessimistic, in the short run, and optimistic, in the long run: the massive pain is coming, and you can’t stop it. But when the market finds equilibrium again, we’ll move forward into the next economic expansion…
Let me reprint the concluding paragraph of Professor Macey from above, as a final salvo for now:
That’s my position in a nutshell…
Yes, they are improvising.
Yes, it’s clear that they have not thought things through, and that this undercuts the confidence of anyone (to whit, all of us) counting on their success.
To pick, but one example, the 3-page Paulson plan was a friggin’ joke. If I want a $10,000 grant for a small research project, I need to supply a more thorough and well-thought out document than they proffered with their request for $700,000,000,000.
Strictly amateur-hour, and it reeked of the incompetence that has marked this Administration’s worst moments (Katrina, the mismanagement of the Iraq War, …).
But Paulson and Bernanke are not Michael Brown. They are capable of much better. And my theory is that they have been held back from acting with greater dispatch, and with better preparedness, by ideology.
Your theory (correct me if I have misconstrued) seems to be that they are simply incompetent. While the glib partisan in me would hasten to agree that every Bush appointee is to be presumed incompetent, unless proven otherwise, I think that’s not the case here.
No, we don’t. Which is why we can’t allow the banking system to go belly up. Sure, it’ll eventually be recreated. But, in the meantime, we’ll be back in the economic stone age.
Think of this as a disaster which, though man-made, is every bit as economically destructive as a hurricane or flood or earthquake. We don’t expect the market to take care of such calamities all by itself. We expect, nay demand, that Government intervene. I think we are well past the point where we can expect this particular crisis to pass without Government intervention.
The US has not suffered a similar financial crisis since 1929. But other, smaller, countries have. Think of Sweden in 1992, or Mexico in 1994, or Russia in 1998, or the Asian Financial Crisis in 1997. The latter is particularly apt, because there you saw a domino effect, as first Thailand, and then one country ASEAN country after another succumbed.
In each case, it required a massive intervention to set the financial system back on track.
In no case did it lead to the demise of Capitalism as we know it.
There have been so many interventions at this point that I don’t even know which intervention to address – but I’ll meet you part of the way: of the interventions on the table, the one that makes the most sense is certainly the recapitalization of troubled financial institutions through equity stakes. Had that been the call from the beginning, we might not be having this conversation.
Not that I think that this is a silver bullet that would have magically cured the ailments of the credit crisis (nor do I think you have such a simplistic view)…but it’s responsive to the immediate need without being overwhelmingly reckless re: the American taxpayer…
Several comments seem to have crossed in the æther.
From the left, it’s kinda expected. From the right, it’s particularly jarring, and rather more disturbing.
I agree.
And, moreover,
* it doesn’t require figuring out how to price these abstruse “toxic” securities that Paulson was going to (and may still) buy.
* it doesn’t undeservedly reward the current owners of those securities (by paying above-market prices for them, which was surely the intention).
* it, as you say, gives the taxpayers a positive stake in the upside.
* it does (effectively) punish existing shareholders by diluting their ownership stake. The Government now owns 80% of AIG. Which means that the previously-existing shareholders now own only 20%. When the Government eventually sells its shares in the company, the price/share will be much lower than it would have been if all those new shares had not been issued (i.e., if they’d just given AIG a handout). Of course, those shareholders will still be better off than if AIG had been allowed to go bankrupt (in which case, they would have lost everything). But, I think correctly, the collateral damage from allowing that to happen (at this particular point in time!) was deemed to be too great.
Had that been the call from the beginning, my portfolio might be 25% larger than it is tonight.
Well, since I shrewdly invested virtually all of my money in credit card debt, my portfolio is roughly the same size as it was to begin with – that’s the bright side of having nothing…
Fareed Zakaria thinks the current crisis might teach people like me a lesson. Perhaps he’s right (in my case, he’d better be!) – but he also thinks it will teach government to live within its means – a wildly optimistic conclusion that I see no basis for reaching…
I moved from equities to commodities awhile ago so my loses are (considerably) less than the broader market. Oh, and I’ve never been invested in banks or financial institutions. But I’m no genius, just have gotten some solid advise.
If the government is taking equity stakes only in institutions that are deemed to be at risk, will you? Will anyone? Or will this, then, end up as more good money following bad?
You are all forgetting that their is criminality involved. Not only in financial institutions, but in the United States Congress. I’d like to see Barney Frank, et al, marched away in handcuffs. They betrayed the public trust. Public servants indeed!