By Edward Harrison
As we head into the New Year, I am trying to look back at the last one with some semblance of a coherent interpretation of events that leads to a strategic vision of the future. I have already touched on stimulus, kleptocracy and crony capitalism as dominant themes for the year 2009.
These posts have been critical of the economic vision presented by the Bush and Obama Administrations. I would stress that I see a lot of overlap in the two Administrations’ economic policies, which is why I use the phrase “the Bush and Obama Administrations” instead of focusing just on Obama.
But, now is the time to offer a review of alternative policy solutions. Bashing policy without pointing to an alternative doesn’t add value. I also believe quite strongly that this exercise will demonstrate that alternative policy solutions did exist – and that they were pointed out at the time. One can only assume that alternative policy solutions were rejected because the Bush and Obama Administrations preferred the solutions they crafted to these. And while, I am most concerned with outcomes, this juxtaposition between what could have been and what is points to the kleptocracy and crony capitalism I mentioned in my last two review posts.
Before I go into my spiel, I want to stress a point I made at the outset of a November post “The less optimistic view of Treasury’s handling of the crisis”:
one doesn’t have to take the view that its efforts to save the banking industry were a deliberate attempt to line bankers’ pockets by transferring money from taxpayers to the banking industry.
I will probably end up flexing my confabulatory muscles like every other pundit out there – making direct or unconscious assumptions about motives, agendas or intent. This is all just speculation – much of it false. It is outcomes that matter, not intentions. And it is the outcomes that leave me unsatisfied with the present policy course.
Change you can believe in
The key issue, in my view, is the desire for change in 2008.
For years, the U.S. had been lecturing others how to run a successful economy. The Mexicans needed to sell their banks to foreign behemoths to succeed. The Asians and the Argentines needed to take their depressionary medicine and eliminate crony capitalism. The Russians also needed to eliminate gangsterism and crony capitalism or no one would invest there. The Europeans were overly regulated and the state was too big. And so on.
Then, after a quarter-century of apparent economic success (1982-2007), the U.S. economic and financial system was close to collapse. The masters of the universe were seen to have brought the economy to its knees because there were vulnerabilities at the core of American-style capitalism. This was an ugly surprise for many – and it was humiliating, just as 9/11 had been on national defense. Change was the watch word.
What kind of change? Last month, I said:
If you asked 1000 people in those exit polls from November 2008 – or even last week, “what would make you know America was headed in the right direction,” you probably would have gotten 700 different answers.
But, one thing is clear: Since January 20th, a lot of people are saying to themselves, “I know change when I see it and this is not it.” That’s what all polls are saying. So, whatever Obama and the Democratically-controlled Congress are doing, it’s not working.
So, people wanted fundamental change and they felt Obama could deliver it. What the specifics were was less important. The key was that whatever changes were made, it reflected a more proportional connection between economic contribution and financial gains as well as elimination of the core vulnerabilities of our system.
More of the same
So, when Tim Geithner says:
I spent most of my professional life in this building. Watching the politics of the things we did in the past financial crises in Mexico and Asia had a powerful effect on me. The surveys were 9-to-1 against almost everything that helped contain the damage. And I watched exceptionally capable people just get killed in the court of public opinion as they defended those policies on the Hill. This is a necessary part of the office, certainly in financial crises. I think this really says something important about the president, not about me. The test is whether you have people willing to do the things that are deeply unpopular, deeply hard to understand, knowing that they’re necessary to do and better than the alternatives.
this is either cynical propaganda or self-delusion. People did not elect your President to do deeply unpopular things. They elected Obama to make the fundamental change that he is not delivering. You may think this is change we can believe in, but polls show Americans do not. This quote encapsulates why you can’t have people who created the mess clean up after it. They are prone to defend their prior policies tooth and nail to vindicate their actions. As I said when reviewing a recent Matt Taibbi piece:
What happens when a company is nationalized or declared bankrupt is instructive; here, new management must be installed to prevent the old management from covering up past mistakes or perpetuating errors that led to the firms demise. The same is true in government.
And Geithner and Summers do not represent change in the least. They were at the center of many of the past decade’s policy mistakes: Lehman, OTC derivatives, and anti-regulation of money center banks.
It’s not difficult to see what’s going on. For Obama, it’s kind of hard to get change when you surround yourself with insiders who have vested interests in the status quo.
Credit Crisis Options
A quote from “America needs a pre-privatization plan” is my jumping off point because it does a good job of framing the policy choices at the time.
To my mind, there are three ways to deal with an insolvent financial institution:
- Bankruptcy. Allow the institution to collapse (like Lehman Brothers)
- Nationalization. Seize the assets of that institution and nationalize it (like Northern Rock, AIG, or Fannie Mae)
- Bailout. Inject capital into the institution in order to allow it breathing room until it can meet capital adequacy levels.
As you can see, governments have tried all three solutions. However, there are vast differences between the three.
The bailout solution is the most ‘anti-free market’ choice and seems to be the favored solution of governments everywhere. It props up organizations, giving them an unfair advantage at the expense of other more prudent institutions. It also acts as a subsidy, which favors domestic institutions over foreign rivals. Bailouts increase moral hazard by rewarding risky and reckless lending practices. And they are often the result of crony capitalism due to the power of the financial services lobby. There are many other problems with bailouts. All around, bailouts are a poor solution.
As you know, the Bush and Obama Administrations chose the third option. Here are a few posts from the crisis detailing the Bush response (for which Geithner as New York Fed Chair shares responsibility). Paulson wanted to allow failed firms to fail. But, he quickly learned the same lesson that the Brits learned during the run on Northern Rock, namely this is a very risky strategy unless you have a well-thought out process to limit contagion (see the first post below).
After the post-Lehman panic, I see the policy as bailouts that are “a naked attempt to preserve status quo” as I say in the Dead on Arrival post below (and I present a coherent policy alternative there). Congress was asleep at the wheel, as usual.
- Lehman’s bankruptcy: putting the cart before the horse? – Sep 2008
- The $700 billion Paulson Plan is dead on arrival – Sep 2008
- The Paulson Bailout Plan is unconstitutional crony capitalism – Sep 2008
- The Paulson plan is not going to make it – Sep 2008
- Congress does need to act on the Economic Patriot Act – Sep 2008
So, when Obama was elected, there was an enormous opportunity to change course. I had pointed to Paul Volcker’s presence in Team Obama as encouraging in October 2008 (Paul Volcker: Obama’s other economic advisor) and November 2008 (Volcker warns how serious things have become).
However, after the election, Obama immediately put Geithner and Summers in charge despite their complicity in the policies that led to crisis. I will sheepishly admit to putting a positive spin on things pre-inauguration (see Crony capitalism in U.S. banking bailout should end from January). But, Geithner and Summers consolidated power over time as infighting begins within Obama’s team forced Obama to cast his lot with Geithner-Summers or Volcker. By March, Marshall Auerback was asking Where’s Volcker? as it became obvious he was being shunted aside.
The path not chosen
So, to sum up, we had an economic and financial crisis of a lifetime. The Bush Administration and the Fed were in disbelief and failed to make enough preparations for the obvious coming failures. An almost religious belief in market mechanisms and an incoherent policy led to disaster with Lehman – after which the Bush Administration got religion about bailouts and crony capitalism.
When Obama came to town, you might have thought his policies would be substantively different. But they were not – not on regulatory reform, auto bailouts or bank bailouts. His was the neo-liberal prescription of the Clinton era – substantively the same as the Bush policies. When I wrote Seven reasons to be skeptical of Obama’s economic plans already in January, this was why.
That’s how things panned out.
Since I detailed some of the policy choices in my review post on crony capitalism, I won’t cover that ground here. I will point out just a few March 2009 posts from Credit Writedowns which I did not mention in the last review posts. They all point to problem’s with Team Obama’s solution in terms of wealth transfers and sustainable outcomes as pointed out by leading economists.
- Is Obama considering nationalisation? – Mar 2009
- Geithner’s Plan: one of the most regressive wealth transfers of all time – Mar 2009
- Roubini: Nationalization “fully on the table” in Geithner’s Plan – Mar 2009
- Krugman: Geithner Plan “won’t work” – Mar 2009
I will use this as a natural place to stress how motives and intent are irrelevant. Think Obama is a bad guy all you want. Think Larry Summers has an alternative agenda all you want. Think the perennial public servant Tim Geithner doesn’t want to do good all you want. Motives and intent don’t matter; outcomes matter.
And here are the posts I feel best represent a number of potential alternative solutions to what we have witnessed from pre-Lehman through March.
- The Swedish banking crisis response – a model for the future? – Aug 2008
- How to tackle systemic malaise – Sep 2008
- The global economy has crashed: we need a comprehensive credit crisis plan – Sep 2008
- The problem with comprehensive banking crisis solutions – Nov 2008
- Seven reasons to be skeptical of Obama’s economic plans – Jan 2009
- What is an economic depression? – Feb 2009
- A conversation with Bridgewater Associates’ Ray Dalio – Feb 2009
- Yves Smith: Nationalization is what the FDIC is doing every week – Feb 2009
- America needs a pre-privatization plan – Feb 2009
- Did Sweden really nationalize its banks? – Feb 2009
- Lessons from Swedish bank resolution policy – Mar 2009
- A few thoughts about the banking crisis response in the United States – Mar 2009
- What would an alternative to bailouts have looked like? – Nov 2009
I’ll finish this off by quoting from my third post “The US Economy 2008” which points to over-indebtedness and a purge of malinvestment as the problem which politicians will refuse to tackle:
The global economy, now supported in the main only by the overextended U.S. consumer, finds itself at stall speed, susceptible to any number of potential exogenous shocks. Ultimately, the economic malaise created by this confluence of events will take years to unwind. A positive outcome to this process is dependent wholly on liquidation of excess credit and consumption.
This process will be extremely painful in the short term, but will lead to a healthy economy long-term. Unfortunately, experience shows that these painful steps will only be taken as a last resort. Moreover, geopolitical events become volatile in a world of economic insecurity, leading to political upheaval and protectionism. Protectionism is a natural outgrowth of nationalist economic policy as it transfers wealth from foreign producers to domestic producers by cutting off access to lower cost excess capacity in the goods in service sectors. However, this also serves to transfer wealth from domestic consumers to domestic producers by increasing the price of goods in the protected sectors, ultimately reducing consumption demand.
For these reasons, I am cautious about the long-term outlook for the global economy and the U.S. economy in particular. The likely outcome for the next decade is one of sub-par global growth with short business cycles punctuated by fits of recession.
Could it be any different?