September 17, 2008

The Republican Economy Needs a Federal Referee

After the American Century

Some months ago I criticized the Bush Administration's decision to give money to taxpayers across the board, rather than focus it where the real need was, in the mortgage market. It was clear to me, but apparently not clear to Republicans, that home forecloseurs threatened the whole economy. In the last week this truth has been demonstrated with frightening clarity. Two of the oldest and largest and once most respected investment houses in the United States have disappeared. Lehman Brothers has gone bankrupt and Merrill Lynch has been purchased by Bank of America. Both got into trouble because the Republicans refused to regulate investment bankers, which meant that a large part of the economy escaped scrutiny from the Federal Government. This created an uneven playing field, where regular banks played by different rules than investment houses that went into banking. A great many irresponsible mortgages were approved. A housing bubble emerged and expanded - and then popped during Bush II's second term.

Bear Stearns was the first big investment bank to collapse, and the Feds brokered a deal to sell it off for a fraction of what had been its value. Quite properly, the regulators did not bail it out. But the underlying problem of unregulated investment banks making risky loans did not go away. In fact, so many people had been encouraged to buy property that they could not afford,that the Feds soon had to rescue Fanny Mae and Freddie Mac, as the two giant mortgage companies were known. These had functioned without serious problems for generations before the Republican true believers in unfettered capitalism let the investment banks run wild. Like athletes on steroids, they bloated up rapidly and looked powerful, but a mere slowdown in the economy, not even a major recession, put them in trouble. The home owners who went into foreclosure ended up dragging down to ruin some of the (once) most respected banking houses in the world. The end is not yet in sight.

Last night the Federal regulators reluctantly came to the rescue of the American International Group, the largest insurance company in the US. A "loan" of$85 billion dollars. I call that welfare for the capitalists. If the Bush Administration followed the logic of deregulation, then it ought to let any such mismanaged company go into bankruptcy, as Lehman Brothers did. But no one dared. The economic truth is that the markets for insurance and investments and real estate are now tied together in so many intricate ways that a gigantic failure like that would start an avalanche that no later intervention could stop. It would be 1929 once again.

For the mismanaged Bush economy is by no means out of the mess that the Republicans have created, both as lawmakers against investment bank regulation and as the the party of Wall Street. If McCain were elected, one can expect more of the same mismanagement. He has never been a supporter of regulation, but rather when things go wrong he has intoned against "greed on Wall Street." Such moralism appeals to non-investors on small incomes, but it is hypocritical for McCain to pretend that the whole problem is due to a few greedy people. McCain and the Republicans generally, do not want to recognize the need for government. On the highway we need police to regulate traffic, so that reckless drivers do not cause major accidents. In the same way, Wall Street banks need some limits (try collateral) and safety controls (such as larger minimum cash reserves) so that foolish loans do not wreck the financial system. Instead, they are rushing in after the fact with an $85 billion bailout, guaranteed by the taxpayers.

McCain naively believes in "market discipline." That is like saying he expects football players not to be rough if there are no referees. Actually, McCain seems to believe in a system in which potential referees can accept payments from players. The New York Times reports that the McCain campaign has received large contributions from investment bankers, including more than $300,000 from individuals working for Merrill Lynch. His contributors are the very people he now condemns for being greedy capitalists.

Senator Obama, in contrast, back in March was calling for investment bank regulation. He has consistently done so. In the current economic meltdown, it is well to remember how well the economy was doing from 1992-200o, when the Democrats were in charge. More than one million new jobs were created each year during the Clinton Administration, and the budget was in surplus, with the national debt rapidly disappearing. In the Clinton economy almost everyone was better off. Obama is calling for a return to that tax system, which did ask wealthy people to pay more, but they ultimately also benefited from growth and a strong economy.

George W. Bush dismantled that system, which was working so well. Americans now have an economy where everyone is losing. Homes are losing value, stocks are falling, and jobs are disappearing. Bush will be remembered as a president who failed both domestically and in foreign affairs. McCain, who voted with Bush II 90% of the time, offers more of the same.