“Le laisser-faire, c’est fini”?
The title quote is attributed to French President Nicolas Sarkozy in Roger Altman’s insightfully sobering piece in the current issue of Foreign Affairs [volume 88, at pp. 2-14]. The topic sentence: “The financial and economic crash of 2008, the worst in over 75 years, is a major geopolitical setback for the United States . . . .” True, the final paragraph concludes, “The United States will remain the most powerful nation on earth for a while longer.” [at 14]. But its standing and influence are badly damaged and there is little that can be done to reverse or limit the effects.
On average, Americans lost 1/4 of their net worth from June 2007 to December 2008. [I am one of those average Americans.] Net worth reductions appear in all assets classes: home equity values down 33% [$4.2 trillion, mine down 20%], retirement savings values down 22% [$2.3 trillion, mine down 25%], other securities investment values down 25% [$2.5 trillion, mine down 20%]. Total value reduction: $8.8 trillion.
Broad stock market indexes fell by nearly half from highs in 2007 to the end of 2008. Altman says this means participants are “anticipating an even worse drop in corporate profits” ahead, although he also notes how the current environment reflects psychological as well as substantive effects, highlighting “deep fright”, “shock,” and a sense of “doom pervading Washington and the U.S. media.” Altman also notes that the recent period shows “a classic pattern of overshooting, [with] markets swinging from euphoria to despair.”
Cures for this substantive and psychic malaise are limited, Altman explains. Interest rates are already very low, so easing monetary policy can do little. Fiscal stimulus, through tax cuts or rebates, are expensive and can only be made in such small aggregate amounts, say $300 billion, to do little in the US’s $15 trillion economy. The US government, with little success to show for it so far, “took the previously unthinkable step of committing . . . $1.5 trillion to direct equity investments in [US] financial institutions” aside from trillions more in support. Also, the US budget deficit is huge, $1 trillion as of October 2008, “the largest nominal deficit ever incurred by any nation,” amounting to 7.5% of U.S. GDP, “a level previously seen only during the world wars.”
Despite there being little government can do to correct the crisis, Altman says, government reform will come, with “sharply tightened regulation”—in banking and securities. Altman says: “There is unanimity that broad regulatory reform is necessary.” But, citing the notoriously maligned Sarbanes-Oxley Act of 2002, responding to corporate accounting scandals, Altman says history suggests “reform will go too far.” There will be over-reaction in regulation, just as there is overreaction in markets.
Adopting the more geopolitical turn of this post’s quoted title, Altman says the financial meltdown means that “the economic credibility of the West has been undermined.” It weakens the “intellectual strength of the Anglo-Saxon brand of market-based capitalism.” Its erstwhile capacity to push back socialism degrades. And the world will follow the US example of government ownership of financial institutions like banks and even industrial enterprises like auto makers.
Altman cautions against any proposals for radical international change along the lines of “a whole new global financial order.” Instead, Altman counsels to focus on a few modest things, prudently in keeping with his concern about over-reaction. First, strengthen the International Monetary Fund (IMF) by increasing its capital base, making it more flexible and getting high-surplus countries like China and the Persian Gulf states to contribute more. Second, China should join the G-8 and/or the G-20 should exert more global influence than the G-8 has done. Third, bank capital adequacy standards (set in the Basel II accords) should be revised, to focus more on building cushions amid prosperity than maintaining target financial ratios from period to period.
Altman’s diagnosis seems spot on. His concern about proclivities to overreact, in markets and in regulation, seems right. The analysis inclines one to consider sober, measured regulatory improvements (although my own list is broader than his). It also suggests reasons to be skeptical about the wisdom of stock markets, prone to bouts of exuberance or depression. It recalls Warren Buffett’s sage advice: be greedy when others are fearful and fearful when others are greedy. That, in turn, makes me think that President Sarkozy’s quoted judgment is premature–or at least an over-reaction.