A Myth Debunked

What has often seemed to be an interminable presidential election campaign is now in its final days. With the economy souring and the banking and financial system suddenly paralyzed, recent polls indicate a shift among undecided voters toward Sen. Barack Obama. Democrats are hopeful, if wary, while Republicans appear increasingly resigned. Everyone is nervous.

It is hard to know what to say—let alone what remedies to recommend—about the unprecedented volatility in the stock market and the frightening succession of bank failures both in the United States and abroad. Retirees, and those expecting to retire in the near future, watch helplessly as the value of their pensions and 401(k) accounts plummet. Was it only four years ago that President George W. Bush and the Republican Party aggressively pushed for the privatization of Social Security? Americans, the president urged, should put their Social Security funds into the stock market. Trust the wizards on Wall Street, not “wasteful” government. Imagine what things would look like now if Bush had succeeded.

The complexity of the financial crisis is daunting, even if the underlying cause—too much borrowed money funneled into risky investments—is familiar enough. Trust among the world’s financial institutions has evaporated. Because it is all but impossible to determine how much banks already owe investors, no one will lend money to anyone else. In a situation like this, most economists and economic historians tell us, only government can restore confidence in the markets. And the only way that can be done is for government to infuse the system with massive amounts of money. This is what Sweden did when its banks failed in the 1990s, resulting in a relatively brief recession and a strong recovery. Japan didn’t use this remedy, resulting in a decade of economic stagnation. Even the Bush administration, long loath to acknowledge that government has an indispensable role to play in the modern economy, has begrudgingly recognized that the financial markets cannot save themselves. At the same time, the administration has been too slow to realize the magnitude of the crisis. Fortunately, it now appears that the $700-billion bailout plan, initially designed to purchase the bad debt of banks, will be used to buy a stake in the beleaguered banks, thus injecting capital more efficiently into the system. This means that these institutions will be partially nationalized, at least for the short term. Sweden resolved its crisis this way, and the British government announced last week that it would do the same. The EU quickly followed. There is a growing sense that coordinated international action is urgently needed if economic calamity, and the political turmoil likely to follow, are to be avoided.

Over the past forty years there has been a strenuous effort, and a surprisingly successful one, on the part of corporate and financial interests, to convince the American people that laissez-faire markets are the fairest, most efficient, and most prosperous way to organize economic life. Government, the mantra goes, is the problem, not the solution. In her vice-presidential debate with Sen. Joe Biden, Alaska Gov. Sarah Palin told voters that she just wanted government to “get out of the way,” and that she didn’t consider paying taxes to be “patriotic.” No one, of course, likes to pay taxes. But as the financial crisis has demonstrated, without taxes and the authority of government, we would deprive ourselves of the tools needed to protect both our economic well-being and our political freedoms.

Given recent events, politicians with strong libertarian and antiregulatory economic records, such as Sen. John McCain, are having a hard time defending their policies. In one sense this is unfair: the deregulation of the investment banking industry can be blamed on Democrats and Republicans alike. Too many Democrats bought into the Republican myth of the omniscience of the market. Government policies have also created strong incentives to invest in real estate. It is fair, however, to note that McCain remains ideologically committed to the view that when it comes to the economy, the less government interference the better. Perhaps the best example is McCain’s health-care proposal: contrary to all the evidence, he thinks increased competition among medical providers will lower costs, and tax credits will expand coverage. Like the financial system, however, health care is an area where government needs to take an active role to protect the common good, and especially the weakest among us. Obviously, government regulation cannot solve all our problems, but it is dangerous to presume, as too many people have, that we can do without it.

October 14, 2008