Lessons from the meltdown
BAD TIMES have a way of clearing away the ideological overgrowth and replacing it with pragmatism.
"I am now a Keynesian," Richard Nixon declared in the tough economic days of 1971.
"There are . . . no ideologues in financial crises," Fed Chairman Ben Bernanke reportedly said last week, as he and Treasury chief Henry Paulson led an excessively ideological administration to launch the biggest bail-out in US history.
If there are fewer ideologues going forward, we might just take some lessons to heart. For example:
Self-regulation: The oxymoronic bubonic tonic
One notion zealous free-marketeers hold dear is that markets will regulate themselves because the downside of excessive risk will keep investment titans from reckless behavior. The chaos of the last two weeks, which has brought the long, swaggering reign of investment banks to an astonishing and ignominious close, has given the lie to that notion. With Merrill Lynch sold off like Bear Stearns before it,
Dollars and Sense and Sensibility
Further, despite the oft-repeated assertion that markets are rational, in the short term, Wall Street can get as giddy as a teenager in love. The pursuit of profit too often trumps prudence, and not because of Wall Street greed alone. We saw that in the late 1990s, when Internet companies with neither products nor profitability suddenly became the Belle of the Bubble Ball. When Main Street investors saw others making gold-rush rates of return, many didn't want to settle for less.
We're now suffering the after-effects of a similar phenomenon, which saw Wall Street throw caution to the wind in its willingness to ride up, up and away on a housing bubble it helped inflate.
Further, when everyone is making money, it's hard for regulators to play skunk at the garden party. Says one senior federal regulator: "The candidates and others are talking about regulators asleep at the wheel. It wasn't so much being asleep, but it takes a big pair of cojones to try to stop the money train."
One True Key: Transparency
For the market to work well, investors have to be able to assess risk accurately. With the blizzard of bewilderingly complex investment vehicles, that's increasingly difficult. Conversely, those same instruments make it easier for firms to divorce risk from reward - until the market turns, that is. Last week, one of the things that reportedly impeded insurance giant AIG as it tried to raise capital was that the company couldn't say with certainty the full extent of its problems.
The Ostrich Impulse
This problem didn't spring fully grown from the head of Zeus - or Mammon. It's been building for at least two years as housing prices have declined and mortgages have gone into default.
As this crisis has demonstrated, problems ignored don't disappear, they sometimes become more dire. So it's time to ask this question: What others are we ignoring?
Here's one: The unsustainable state of our national finances. Our budget is roughly $400 billion out of balance. Our national debt is snowballing. And our projected long-term fiscal imbalance is simply staggering.
As it is, key policymakers are convinced the federal government can't afford not to intervene in the market crisis, but neither can we really afford the remedy. With some luck, we'll recoup a goodly part of it, but the fact remains that the $700 billion initial cost of the bailout will simply be more money the US will have to borrow.
Our massive borrowing can't and won't continue forever. "We need to learn a lesson and take preemptive action to try to prevent what could be a much greater crisis," says former comptroller general David Walker.
Yet in this presidential campaign, the talk's been of tax cuts and new government spending, with little emphasis on the need to deal with the nation's deficit, debt, and unfunded obligations.
If we don't wake up, someday our kids will look back in despair at the way we once again buried our heads in the sand.
Scot Lehigh can be reached at lehigh@globe.com. 