Candidates should use cau­tion on econ­omy

The Washington Times Weekly - - Commentary - Tony Blank­ley

As of this Sept. 15, United States Fed­eral Re­serve and Trea­sury Depart­ment poli­cies have en­tered the pres­i­den­tial elec­toral po­lit­i­cal de­bate. While, as a rule, I am in fa­vor of candidates for high of­fice dis­cussing pol­icy, I am in­clined to want to make an ex­cep­tion for th­ese ar­cane, yet vi­tal, pol­icy zones. Not only do none of the four candidates know much about fed­eral re­serve poli­cies, but even their ad­vi­sors may not be amongst the very few ex­perts in this ar­cane area.

But worst of all, the am­bi­gu­i­ties and sub­tleties of such del­i­cate fi­nan­cial crises man­age­ment de­ci­sion-mak­ing are sin­gu­larly un­able to be com­pre­hended by slo­gans and phrases.

And yet, both the Obama and McCain cam­paigns jumped out of the box on Mon­day with the as­ser­tions that they didn’t want a tax­payer funded bailout, and they both called for com­pre­hen­sive and tighter new fi­nan­cial reg­u­la­tions. I think I would rather have the candidates ly­ing about each other’s char­ac­ter flaws than dis­cuss Fed pol­icy in pub­lic. I cer­tainly don’t claim ex­per­tise, but let me point out a lit­tle bit of the his­tory of the con­fu­sion.

Let’s go back for a mo­ment to the al­leged his­toric mother lode of hard-learned Fed pol­icy wis­dom — the Stock mar­ket crash of 1929 and the fol­low­ing Great De­pres­sion. Ini­tially, in late 1929 and early 1930 the Fed­eral Re­serve did make ma­jor pur­chases of se­cu­ri­ties and cut the in­ter­est rate from 6 per­cent to 4 per­cent.

But by not bail­ing out banks in the three great runs on banks of late 1930, spring 1931 and March 1933 (re­sult­ing in 10,000 banks go­ing out of busi­ness), Trea­sury Sec­re­tary An­drew Mel­lon’s fa­mous (though not strictly fol­lowed) ad­vice, “liq­ui­date la­bor, liq­ui­date stocks, liq­ui­date real es­tate” be­came the prime ex­am­ple to his­tory of what not to do dur­ing a fi­nan­cial panic.

And in­deed, the les­son learned from those events has been that the Fed should make sure banks have enough re­serves to cover de­posits. Quick and sus­tained in­ter­ven­tion has been the rule.

But if one lis­tens care­fully to the pub­lic com­ments of the last few months, one hears praise for at least the echo of an al­legedly cold-hearted Mr. Mel­lon. As Trea­sury Sec­re­tary Hank Paul­son said on Sept. 15: “Moral haz­ard is some­thing I don’t take lightly.” This cur­rently very pop­u­lar propo­si­tion cor­rectly ob­serves that in free mar­kets, in­vestors who take un­due risk must pay — and be seen to pay — the price for such im­prov­i­dence. This propo­si­tion is un­der­girded by the fa­mous maxim of Joseph Schum­peter that fail­ure in the mar­ket­place is part of the creative de­struc­tion of cap­i­tal­ism.

Or, as old Mr. Mel­lon said along with his liq­ui­da­tion tril­ogy: “Val­ues will be ad­justed and en­ter­pris­ing peo­ple will pick up the wreck from less com­pe­tent peo­ple.” So, when do we let eco­nomic na­ture take its healthy course, and when do we in­ter­vene with tax­payer dol­lars to bail out large fail­ing in­sti­tu­tions? Last week poor old Lehman Broth­ers was be­ing cheered into bank­ruptcy by an un­holy troika of com­men­ta­tors, ex­perts and pres­i­den­tial candidates — as an ex­am­ple “pour en­cour­ager les autres” (the full quote from Voltaire — in trans­la­tion, is “in Eng­land, it is good, from time to time, to kill an ad­mi­ral, to en­cour­age the oth­ers.”)

But only two weeks ago, not only both candidates for pres­i­dent, but even such a free mar­ket man as Larry Kud­low called the tax­payer back­ing of Fred­die Mac and Fan­nie Mae “ a nec­es­sary action [to] stop a global money melt­down — but it raised the stakes for tax- pay­ers once more.” And Kud­low — who I both ad­mire and con­sider a friend — also backed the bailout of Bear Stearns in or­der to “safe­guard the bank­ing sys­tem and the whole global fi­nan­cial struc­ture.” So slo­gans like no more tax payer bailouts are mean­ing­less ver­biage. (Al­though what is said in pres­i­den­tial cam­paigns can some­times, if we are not care­ful, ac­tu­ally be­come gov­ern­ment pol­icy the fol­low­ing year.)

In fact, it is al­ways a mat­ter of nice judg­ment whether the sys­tem needs pro­tec­tion or whether it can with­stand the tough but fair work­ings of the mar­ket­place. Last week the con­sen­sus judg­ment was that Lehman fell into the lat­ter cat­e­gory. Time will tell be­cause the mar­kets and the pub­lic had to men­tally ab­sorb not only the Lehman bank­ruptcy, but the Mer­rill Lynch pur­chase by Bank of Amer­ica and the pos­si­ble fa­tal illiq­uid­ity of AGI, the in­sur­ance gi­ant. The first re­ac­tion was a 504 point drop.

It may be months be­fore we know whether it was wise or fool­ish to “pro­tect the tax­pay­ers.”

But here is the kicker. About a year ago, the Fed held about $800 bil­lion in se­cu­ri­ties to use to fi­nance bailouts and for other pur­poses. As of last week they are down to about $475 bil­lion in as­sets. If things get worse and per­sist, they may not have enough se­cu­ri­ties to act in the fu­ture.

Tony Blank­ley is a syndicated colum­nist.

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