A government cure to the sliding economy
WHAT HAD been economic shivers have become violent chills as the credit contagion spreads.
That crisis has Federal Reserve Chairman Ben Bernanke racing about like a doctor confronting a raging epidemic, scrambling to fortify the financial system, forestall panic, and prevent the problems from spreading.
In the short run, Sunday's Fed-facilitated takeover of Bear Stearns by JPMorgan Chase may stave off a cascading series of financial institution failures. But it's also clear that, George W. Bush's official optimism notwithstanding, the country is slipping into serious recession, and that a good deal more needs to be done.
If this crisis has illustrated anything, it's that the government has an important role to play in restoring confidence in the credit markets, and in preventing this kind of crunch from hurting the economy again.
"A year ago, we were being told, you have to deregulate more," says US Representative Barney Frank, chairman of the House Financial Services Committee. Now, "we are going to have to save capitalism from the capitalists."
Ideas abound about how to repair the system. For one, a realistic assessment of risk needs to be reinserted into the investment equation.
"The notion has been that . . . financial institutions are smart enough to manage their risk, so they need to hold less capital as a buffer against shocks," says Barry Eichengreen, professor of economics at the University of California, Berkeley. "This crisis has taught us that that was way too optimistic."
Thus the government should require financial institutions to maintain larger capital reserves when they are dealing with complex investment vehicles.
Another way to ensure that financial houses put proper focus on risk, says Eichengreen, is to require that institutions which convert mortgages into securities keep a specified share of those securities on their own balance sheets.
Government also has a part to play in easing the pain for homeowners facing foreclosure. The trick, however, is to target that aid in a way that helps borrowers rather than simply bails out lenders or real-estate speculators.
Further, "we are not doing these people any favors if we work out a refinancing scheme that keeps them in a home they paid way too much for," says Dean Baker, co-director of the Center for Economic and Policy Research, a liberal-leaning Washington think tank. "They are going to be paying more to stay in that home than if they ended up renting a comparable place, and they don't end up with any equity."
Under a plan Frank proposed last week, if mortgages were written down to an affordable level, one based on the current appraised value of the home, the Federal Housing Administration would then facilitate the refinancing and guarantee the loan.
"What we are going to say is that if the people who hold the paper are prepared to write down those loans . . . to a point where the borrower can repay them, we will have an FHA guarantee so we can resell them in the secondary market," Frank says.
With housing market woes stalling construction, government action may also be needed to keep the construction sector busy, says James Galbraith, an economist at the Lyndon B. Johnson School of Public Affairs at the University of Texas.
"Why not think of this as an opportunity to start focusing on things that have to be done?" says Galbraith, who suggests putting hardhats to work repairing crumbling infrastructure.
Yes, that would have a significant price tag - but then, so will letting those workers fall idle.
Another way to provide work for that sector would be to offer larger (but time-limited) tax credits to homeowners to make their homes energy efficient, says Baker.
"That is not going to reemploy everyone who has lost their job, but it could go a good part of the way," he says.
"And that way we get something enduring rather than sending them a check and hoping they spend it at
Still, as home values fall, the economy weakens, and the dollar slumps, millions of American are certain to feel the pain from this meltdown.
That's why it's important to remember the central lesson of this crisis: This isn't a problem caused by too much government, but by too little.
Scot Lehigh's e-mail address is lehigh@globe.com.
