WASHINGTON – Historic. Breathtaking. Revolutionary.
It would be hard to find a superlative that would overstate how much the parameters and contours of American economic policy have been reshaped over the past two weeks.
The degree of government intervention into the workings of the private marketplace is unprecedented. Three giant financial institutions taken over directly. Government purchases of vast quantities of hard-to-sell assets from banks, investment banks and anyone else whose demise might threaten the financial system. Trading outlawed in an entire class of securities. A government guarantee extended to a whole new category of investments.
Laws have been stretched until they are barely recognizable – like the one, from the days of the gold standard, that authorizes the Secretary of the Treasury to buy and sell the precious metal, now used to authorize a wholly new insurance program for money-market funds.
Roles have been expanded beyond anything that could have been imagined only weeks ago, like the central bank taking control of a giant insurance company.
And tossed aside have been longstanding conventions, such as the quaint ideal that independent agencies such as the Securities and Exchange Commission, and the Federal Reserve should keep a proper distance from the executive branch.
The amount of taxpayer money committed, or about to be committed, to this rescue effort is staggering – easily a trillion dollars, when all the loans, purchases and guarantees are added up. While most if not all of that is likely to be returned to the Treasury, it still represents a massive shift of liability to the balance sheet of the U.S. government.
All that, to save free-market capitalism from its own excesses.
It should tell you something about the critical condition of the financial system that both free-market zealots of the right and angry populists of the left may be willing to put aside ideology and commit themselves to speedy passage of legislation whose details they have yet to see, but the mere prospect of such legislation drove the Dow Jones industrial average up 700 points over two days. Emerging from meeting Thursday night at the Capitol with top officials of the Treasury, the Fed and the SEC, congressional leaders looked like deer caught in the headlights of an oncoming eighteen-wheeler.
It is an exaggeration, and a journalistic cliche, to say that after the events of the past two weeks, the U.S. economy will never be the same. Despite the record volume and volatility on financial markets, stock prices and benchmark interest rates have pretty much returned to where they were. And in most households, and most companies outside of Wall Street, life goes on pretty much as usual. Moreover, officials have taken pains to emphasize that most of the recent initiatives are temporary.
But in terms of the political economy, there is little doubt we are witnessing a once-in-a-generation sea change. It will no longer be an easy applause line for a politician to declare that government is the problem and that markets always know better than regulators and politicians. With Bear Stearns and AIG as their rallying cry, citizens will demand the same kind of financial security and protection as bondholders of big banks and counter-parties of hedge funds. Debates about the competitiveness of U.S. markets will focus less on how little regulated they are and more on how much protection and transparency they offer to investors. It will be harder to deny essential government agencies the talent, money and respect they need to do the job right.
An interesting comparison can be made between Hurricane Katrina and the current financial crisis, which symbolically has now stranded a number of rich investors on the roofs of their mansions, crying out to the government to be rescued.
When we look back, we may find that this crisis, like Katrina, was a turning point in public perceptions and expectations of government – about its competence in dealing with inevitable crises and its ability to take steps ahead of time to assure that the damage is limited and the most vulnerable are protected.
No doubt there will be those who see in this crisis further proof of the inevitable decline of the United States as a world economic power. In fact, it may be just the opposite. The wild swings over the past week in financial markets from Moscow to Mumbai, were only the most recent reminder of the increasingly global nature of capital flows and the risks of financial contagion. They also were a reminder that, in times of stress, global investors still seek refuge in the safety of the U.S. dollar, U.S. Treasuries and the skillful crisis management of U.S. policy makers.
Now U.S. taxpayers have been asked to come to the aid of banks and financial institutions that, while nominally American, have long since become global players. Meanwhile, foreign banks and investors are also benefiting significantly from the U.S. government initiatives. While that is the burden that comes with being the world’s leading economic power, it raises the question of whether some of the costs and risks of our trillion-dollar rescue should be shared with other countries, through the International Monetary Fund.
Oh, and stay tuned. The weekend has only just begun.
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