Bush’s New Deal?

The Bush administration is “working on a sweeping series of programs that would represent perhaps the biggest intervention in financial markets since the 1930s, embracing the need for a comprehensive approach to the financial crisis after a series of ad hoc rescues,” Deborah Solomon and Damian Paletta report for WSJ.

At the center of the potential plan is a mechanism that would take bad assets off the balance sheets of financial companies, said people familiar with the matter, a device that echoes similar moves taken in past financial crises. The size of the entity could reach hundreds of billions of dollars, one person said.

Another proposal would be the creation of federal insurance for investors in money-market mutual funds, coverage akin to the insurance that currently safeguards bank deposits. The move is designed to stem an outflow of funds as consumers start to worry about even the safest of investments, a sign of how the crisis is spreading to Main Street. There is $3.4 trillion in money-market funds outstanding.

In addition, the Securities and Exchange Commission proposed a temporary ban on short-selling on 799 financial stocks. The ban, which is effective immediately, is set to last for 10 days, but could be extended for up to 30 days.

The mere release of this trial balloon has bolstered the confidence of the stock markets both here and abroad. Even the Russian market, which has been in a free fall in recent months that makes what’s happening here look like a rounding error, has rebounded nicely.

Many have already noted the irony of such a sweeping intervention in the economy coming from a Republican president ostensibly committed to the free market.  Then again, when the Fed is buying up failing insurance behemoths, it’s rather hard to keep up the pretense of moral hazard and laissez fairre.

Then again, as Jim Henley notes, even libertarian minded folks like Megan McArdle and Tyler Cowen aren’t exactly advocating that the government do nothing in this situation.   Arnold Kling is perhaps the most vociferous of the established libertarian econobloggers on this one, but even he’s mostly lamenting that we’re bailing out institutions rather than individuals.  It seems that virtually no one is standing by their free market principles these days and that the rather anti-market notion of “too big to fail” is now received wisdom.  Indeed, writing in the Financial Times, Charles Goodhart proclaims this is “Not the time to worry about moral hazard“!

If that doesn’t make your head spin, how about this:  Former Clinton Labor secretary Robert Reich has a blog post out proclaiming “The Bailout of All Bailouts is a Bad Idea.”  He’s not so much opposed on principle, though, but practicality arguing that we don’t know how much bad debt there is and that a bailout may impose massive cost on the taxpayer without actually fixing the problem.   He proposes an alternative Big Government solution:

A better idea would be for the Fed and Treasury to organize a giant workout of Wall Street — essentially, a reorganization under bankruptcy, for whatever firms wanted to join in. Equity would be eliminated, along with most preferred stock, creditors would be paid off to the extent possible. And then the participants would start over with clean balance sheets that reflected new, agreed-upon rules for full disclosure, along with minimum capitalization. Everyone would know where they stood. Bad debts would be eliminated. Taxpayers wouldn’t get left holding the bag. And there would be no “moral hazard” incentive for future financial wizards to take giant risks with other taxpayers’ money.

I don’t have the financial expertise to assess that idea but, frankly, it sounds better than massive corporate welfare.

An interesting aside:  I did a roundup piece, “Financial Crisis: View from Europe,” this morning for New Atlanticist.  The lede:

The deepening and spread of the U.S. financial crisis and the government’s late move to step in to offer regulatory oversight and bailouts might reasonably have been expected to generate a round of “I told you so’s” from Europe.  After all, crises in the American economy have enormous ripple effects around the world, the Bush administration is far from popular, and the Europeans have chided America’s laissez faire approach for years.  Yet, those who have read the major European papers available in English over the last week found most reporting on the subject pointing the fingers at domestic leaders.

This is a global crisis and, like it or not, there’s only so much the U.S. government can do to fix it.

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James Joyner
About James Joyner
James Joyner is a Security Studies professor at Marine Corps University's Command and Staff College and a nonresident senior fellow at the Scowcroft Center for Strategy and Security at the Atlantic Council. He's a former Army officer and Desert Storm vet. Views expressed here are his own. Follow James on Twitter @DrJJoyner.

Comments

  1. Michael says:

    I don’t have the financial expertise to assess that idea but, frankly, it sounds better than massive corporate welfare.

    The problem I see is that creditors will be paid off “to the extent possible”, meaning they will be losing value on their holdings, which may well put them in financial difficulty. This really does seem to be a zero-sum game, where somebody has to lose.

  2. sam says:

    “Not the time to worry about moral hazard“!

    As if those very, very large financial entities, whose actions have world-wide ramifications, don’t subtend those actions with moral hazard. I’m not saying the guys running those institutions have “moral hazard meetings” monthly, but it strains credulity to suppose that in the back of their minds they don’t believe Uncle Sugar will come to the rescue if things go south. I don’t think I’m being cynical here.

  3. Steve Plunk says:

    The Fed loaned money to AIG. The security for that loan is equity in the company if it defaults but the Fed has not intention of running an insurance business.

    The government’s “bailout” here is on solid moral ground since this problem can be traced back to Fannie Mae and Freddie Mac. Since government caused the problem they have responsibility.

    The mortgage giants were treated as governmental entities, backed by the government, and staffed by government appointees. Funny how all those responsible are walking away without any consequences.

  4. Steve Verdon says:

    It seems that virtually no one is standing by their free market principles these days and that the rather anti-market notion of “too big to fail” is now received wisdom.

    Ah-hem. What?