In a free econ­omy, Amer­ica will re­cover

The Washington Times Weekly - - Commentary -

We can fix this. If noth­ing else, that’s the mes­sage I hope read­ers take away from this col­umn. Of course, the “this” is the run on the world bank­ing sys­tem. Stock mar­kets have plunged glob­ally, gold prices have shot up, and U.S. Trea­sury bill rates have plum­meted to 10 ba­sis points, the low­est since the 1950s.

We’re wit­ness­ing a des­per­ate flight to safety by in­vestors. Folks are run­ning away from fi­nan­cial as­sets and fi­nan­cial in­sti­tu­tions sim­ply be­cause con­fi­dence has dis­ap­peared.

Last week, Trea­sury Sec­re­tary Hank Paul­son said “no” to a gov­ern­ment bailout of Lehman. Paul­son and Ben Ber­nanke then took over AIG with an $85 bil­lion bailout, with the Trea­sury is­su­ing roughly $100 bil­lion in new T-bills so the Fed has the cash to re­sus­ci­tate AIG.

All this was nec­es­sary. A col­lapse of AIG would have been un­fath­omable — it is sim­ply too in­ter­con­nected glob­ally. But it turns out this res­cue mis­sion only el­e­vated in­vestor fears. Share­hold­ers are ask­ing: “Who’s next?”

The bears are now raid­ing Mor­gan Stan­ley and Gold­man Sachs, two na­tional trea­sures. Mean­while, the Re­serve Fund — an orig­i­nal money-mar­ket fund launched by Bruce Bent, a hard­nosed friend of mine who for decades has sup­ported con­ser­va­tive po­lit­i­cal causes — has seen its net as­set value drop from $1 to $0.97. That’s a shocker. And the rea­son? The fund’s hold­ings of Lehman com­mer­cial pa­per were un­sup­ported by let­ters of credit.

Money-mar­ket funds are sup­posed to be safe havens for mom and pop — for Mary and Joe in McKeesport, Pa. But ev­ery­body now wants T-bills and gold.

Well, it’s time for some per­spec­tive. The world is not com­ing to an end. The stock mar­ket has tum­bled, but it’s still over 10,000. In late 2002, it was 7,500 and in mid-1982 it was 750. Are things re­ally that bad?

With home prices fall­ing, fore­clo­sures and de­faults are at the root cause of the run against all man­ner of mort­gage-re­lated bonds held by the banks. But as in­vest­ment guru Don Luskin points out, fore­clo­sures to­day are less than 3 per­cent. Dur­ing the 1930s, they were 50 per­cent. Or how about the un­em­ploy­ment rate? To­day it’s 6.1 per­cent. Back in 1982, it was near 11 per­cent; for most of the 1930s, it was over 20 per­cent.

As the oil bub­ble pops, the un­der­ly­ing inflation rate is some­where be­tween 2 per­cent and 3 per­cent — quite un­like the dou­ble-digit hy­per­in­fla­tion of the 1970s. Home prices them­selves have fallen be­tween 10 per­cent and 20 per­cent, but they’re still about 50 per­cent higher than at the start of the decade.

And there are constructive pol­icy mea­sures that can help fix the mar­ket’s prob­lems.

In­vestor Zachary Kara­bell writes per­sua­sively in the Wall Street Jour­nal that “mark-tomar­ket ac­count­ing in the af­ter­math of the En­ron scan­dal makes no sense at all.” Many banks have taken huge losses on mort­gage-backed se­cu­ri­ties and their de­riv­a­tives be­cause the SEC in­sists on mark-to-mar­ket. But Mr. Kara­bell asks: Why knock down th­ese bond val­ues, some­times by as much as 100 per­cent, when the un­der­ly­ing home val­ues em­bed­ded in the mortgages have only dropped 10 per­cent to 20 per­cent? And in the long run, the hous­ing mar­ket will re­cover, as it al­ways does.

Bad ac­count­ing rules like this are sink­ing the fi­nan­cial sys­tem. And why hasn’t the SEC re­stored the uptick rule to stem cas­cad­ing share-price de­clines trig­gered by manic short-sell­ers? Short­sellers are an im­por­tant part of the stock mar­ket, and they add liq­uid­ity at cru­cial junc­tures. But un­til July 2007, they could only short a stock af­ter the share price rose, not while it was con­tin­u­ing to de­cline. The SEC also should re­store the net-cap­i­tal rule, which lim­its banks to a 12- to-1 lever­age ra­tio gov­ern­ing their debt. Over-bor­row­ing by Wall Street is what got many firms into deep trou­ble.

A gath­er­ing con­sen­sus also seems to be form­ing around a new ver­sion of the Res­o­lu­tion Trust Corp., which ef­fec­tively dis­posed of bad sav­ings-and-loan as­sets in the early 1990s. A new RTC could pur­chase un­der­wa­ter as­sets that pro­lif­er­ate through the fi­nan­cial sys­tem and are clog­ging the credit and loan ar­ter­ies of our banks.

We clearly are in an emer­gency mo­ment. But the gov­ern­ment should opt for smart reg­u­la­tory action rather than broad-based in­ter­fer­ence that could sti­fle the free econ­omy. On Thurs­day af­ter­noon, as ru- mors spread that Paul­son was talk­ing Pres­i­dent Bush into a new RTC, the stock mar­ket soared 400 points. That’s what I call an en­dorse­ment.

The pes­simists are now herald­ing the end of cap­i­tal­ism or a per­ma­nent de­cline of Amer­ica. I don’t be­lieve that for one mo­ment. Spe­cific reg­u­la­tory re­forms can get us out of this fix. And most of all, pol­i­cy­mak­ers must main­tain the low-tax, low­in­fla­tion, open-trade for­mula that has pro­pelled this na­tion’s econ­omy and pro­duced so much pros­per­ity for so long.

I say, never sell Amer­ica short.

Lawrence Kud­low is a na­tion­ally syndicated colum­nist.

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