“Le laisser-faire, c’est fini”?

dollar sign.jpgThe 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.

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13 Responses

  1. Fannie Mae and Freddie Mac were government entities in all ways except their technical designation as private companies. They had special federal borrowing rights, a special regulator controlled by congress, and the implicit backing of the federal government.

    Fannie was a government agency until Pres. Lyndon Johnson made it off balance sheet and half-private in 1968, to reduce the apparent government deficit at the time of the Vietnam War. The implicit government guarantee gave them the power to borrow whatever funds they wanted, to buy mortgages and issue mortgage backed bonds. This was $5.4 trillion at one point in the last two years, including $1.4 trillion in sub-prime mortgages.

    The federally approved ratings agencies S&P, Moody’s, and Fitch owed their profitability to political favor, and they came under pressure to give AAA ratings to the new mortgage backed bonds and the highly technical (and now understood as risky) CDO’s (collateralized debt obligations). This allowed the bonds to be sold to financial institutions around the world. This put a stamp of approval on bonds by Fannie, Freddie, and huge volumes from private issuers.

    Government oversight committees did not mistakenly overlook these developments; this was all government policy.

    If these businesses had been designated as official agencies of the government, then the financial crisis would be correctly seen as a failure of a massive, off-budget, government program. However, because they were unofficial government agencies (the creatures of government policy, power, and influence), the cry is that the free market has failed. So, in the greatest irony, government argues for greater regulation and management of business and the people’s lives.

    “We Guarantee It”

    A collection of references to information about the causes of the mortgage and financial crisis. How the government directed massive resources by implicitly guaranteeing the actions of Fannie Mae and Freddie Mac.

  2. A.J. Sutter says:

    I read Altman’s piece a bit differently. He seems to be in denial about the role that Anglo-Saxon economic thought may have played in creating this crisis. He shows no interest in questioning the intellectual premises of the past decade or more.

    To put the “intellectual strength” quote in context, he says “[F]or decades much of the United States’ influence and soft power reflected the intellectual strength of the Anglo-Saxon brand of market-based capitalism. But now, the model that helped push back socialism and promoted deregulation over regulation … is under a cloud. The U.S. financial system is seen as having failed,” (emphasis added). He does not say that this intellectual model has been weakened. He goes on to chide Sarkozy and Berlusconi for “making fiery speeches about protecting their domestic companies from being acquired by foreign interests — hardly a message consistent with modern economics.”

    Similarly, he locates the “underlying cause” of the crisis in “the (invariably lethal) combination of very low interest rates and unprecedented levels of liquidity.” He blames the Fed for the interest rates, but “The liquidity reflected, among other factors, what Federal Reserve Chair Ben Bernanke has called ‘the global savings glut’,” particularly in Asia. Again, apart from his dissing of the Fed, he is offshoring the blame: Asian savers now join the ranks of the culpable along with those who “see” the US financial system “as” failed. As if Americans’ tendency of not saving couldn’t be part of the problem.

    Living in one of those Asian countries, I can report that folks here are not interested in neoliberals blaming them for saving too much, and calling on them to spend more. The approval ratings of the current Japanese cabinet are in a spectacular tailspin for ramming through a stimulus package in line with this aspect of “modern economics”. Moreover, if you actually read the writings of French economists, you will discover that there is a much broader range of thinking about economics (including the Anglo-Saxon view, but many other viewpoints besides) than in the States. Though it may be effective “fiery” rhetoric to present “socialism” in the undefined, monolithic way that Altman does, Americans deserve a more thoughtful analysis of what is being pushed back and whether it ought to be.

  3. A.W. says:

    Declarations of the imminent demise of capitalism come by about as regularly as the latest “Farewell Tour” for the Rolling Stones and is generally about as credible.

    So… the government regulations lead to a complete economic catastrophe and that leads us to think we need… more government regulation. Can’t argue with that.

    And of course let’s not talk about Mark Steyn’s point about the looming disaster coming to europe.

  4. E.L. says:

    “One of the methods used by statists to destroy capitalism consists in establishing controls that tie a given industry hand and foot, making it unable to solve its problems, then declaring that freedom has failed and stronger controls are necessary.”

    -Ayn Rand

  5. A.W. says:

    E.L. Awesome quote. fits this mortgage mess to a T.

  6. Yeah, awesome, all those controls on the mortgage industry created this mortgage mess we’re in.

    Right on.

    Let’s have more chapter and verse from one of the most brilliant philosophers and best writers of the twentieth century.

    Awesome.

  7. A.J. Sutter says:

    I admit it’s kind of arbitrary to select this particular post as an occasion to remark on some readers’ frequent chorus of comments on this blog railing against government intervention, but the mention of laisser-faire in the post’s title may be a sufficient excuse.

    The commenters’ critique is conveniently based on a counterfactual, in that there has never been a period in US history (at least, since before the 1929 crash, or even earlier, since before antitrust regulation, or even earlier, prior to the abolition of slavery) without some form of government regulation of the economy. So there’s always some government “intervention” that can be pointed to; this seems to absolve everyone from documenting an affirmative case, in which society was much better off without government regulation of any kind. This gives a de facto circularity to their argument. If someone cares to come forward with an historical example, and explanation of why that was superior, it would be helpful — provided, of course, that the example involves an economy in which none of the actors took advantage of the particular form of government regulation known as corporation laws, nor of any other form of legislated limited liability.

  8. Mike says:

    True, mortgage problems are not the root cause of this crisis. But low interest rates and too much liquidity aren’t either. What the problem is is that the US “middle class” is such in name but not in income.

    Though male earnings have been stagnant since the 1970s, family income could try to keep up a middle class lifestyle with the entry of women to the workforce. But womens’ income has been stagnant as well. As family income started to fall behind a middle class lifestyle, families did use the increasing housing “values” to take money out of their home through the mortgage mechanism. Then the housing bubble burst, so those techniques will not longer work.

    Rather than the common complaint that union wages in the auto industry are the problem, the problem is that all too few people have jobs that produce middle class family incomes.

  9. A.W. says:

    Shorter Patrick: “Booooo!!! Hissss!!! I can’t say anything substantive, so… Boo!!! Hisssss!!!”

    Grow up.

  10. A.W. says:

    A.J.

    The fact is that the government, from the 70’s, has pushed banks to make subprime loans. When many of those loans when bad (surprise, surprise), then, the government can’t escape blame.

    The fact that regulation continually leads to market distortions and even market failure, suggests to me that as a general rule of thumb, less regulation is better. Which is not to say anything should go, but I think we intrude far too deeply into the market already.

  11. “E.L. Awesome quote. fits this mortgage mess to a T.”

    Thanks for setting the bar so high, but I can’t reach it until I grow up.

  12. A.W. says:

    Patrick

    Wow, you have fully descended into being a comment troll, stripped of any pretense of content and continually mendacious.

    In this example you ignore the fact that unlike you I had already made a substantive comment. You also ignore the difference between criticism and praise. When you agree with someone you don’t have to say why. but if you disagree, then you need to back it up. Otherwise you are just a troll.

    Pathetic.

  13. What A.J. said (here and before). And what Frank Pasquale has said elsewhere. But regular readers no doubt know I how feel about such matters so there’s no need to repeat myself.

    Now that I’m a troll, I suppose I can’t grow up.