MORALIZING WON'T FIX THE ECONOMY
How should we talk about the financial crisis?
How should we talk about the financial crisis? Right now, emotional language is pervasive. Fear is a natural, almost inevitable reaction to the apparent disappearance of over $8 trillion in retirement savings. Anger follows fear, as we look for someone to blame among many worthy culprits. Confusion is equally prevalent, as we try to figure out what a “credit crisis” is and why it has threatened to destroy the stock market and bring the larger economy to a standstill. Disillusionment is perhaps the most generous way to describe how most feel about investment bankers, those “Masters of the Universe” who proved so feckless in their stewardship of other people’s money, as well as their own. Bitter disappointment is also directed toward government regulators who apparently dozed through the monstrous inflation of the debt bubble. Alan Greenspan’s Federal Reserve, which kept interest rates too low for too long after the tech bubble burst in 2000, is also guilty of recklessly fueling the debt mania. Hubris drove much of the financial system. The vertigo and nausea induced by the volatility of the stock market have compounded these emotions, leaving us contemplating not just personal financial disaster but the possibility of a new Great Depression and the end of the preeminent economic status of the United States.
All of these emotions are understandable responses to what is happening. There are lots of reasons to be frightened, angry, and even nauseated. The current crisis is extraordinary, and even optimists believe that the Great Unwinding of the debt binge will take at least a couple of years. There will be a passionate political debate about our economic fate and about what government and market players should do. Strong feelings are inevitable, given the stakes. Passionate disagreement, however, often turns superficially moralistic. To be sure, it is inevitable that many people will try to explain what is happening in moral terms. Because we are terrified and angry about the impact of something most of us don’t fully understand, the natural tendency is to search for someone to blame. The instinctive response is to demand that the bad guys get punished and innocent victims get saved.
There are many examples of vice trumping virtue in this financial mess, so talking about the crisis and its consequences in moralistic language is to be expected. Greed caused otherwise rational people to act irrationally. Arrogance and excessive pride were pervasive on Wall Street, especially with regard to the complex mathematical models and other novel mechanisms bankers invented to supposedly make risk virtually disappear. Many observers find a rough kind of justice in seeing investment bankers, some of the biggest winners in our grossly unequal economic lottery, finally get their comeuppance. Emotional, moralistic discourse can provide a kind of catharsis.
But moralistic language also inhibits or even prevents clear thinking. It easily slides into a tendentious settling of scores and irrelevant posturing. Worse, it usually becomes a tool of political opportunism, setting the stage for even worse mistakes.
The original plan (put forward by Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke) for relieving the impasse in the credit markets that entailed purchasing mortgage-backed securities and derivatives was widely defined as a “bailout,” even by some of its advocates. As it happens, that term itself implied a highly negative moral judgment, a judgment quickly amplified by popular outrage at the idea of “bailing out” the rich while letting the average Joe go hang. An unusual alliance of populist Democrats with axes to grind, and free-market-obsessed Republicans backed by talk-show motormouth Rush Limbaugh, rejected the initial “bailout” legislation. (Limbaugh inanely claimed, “This is a manufactured crisis.”) When we unpack all this, however, we see illusion and confusion. The plan had its flaws, which the government has addressed by devoting $250 billion of the $700 billion rescue package to direct equity investment in banks, rather than purchases of debt under the Troubled Asset Repurchase Program (TARP). But the plan was never intended to bail out feckless investment bankers. It has not done that, and will not have that effect. If it bails out anything, it will bail out a profoundly compromised credit market and a financial system in which every bank, savings and loan, and money-market fund must operate. The Treasury Department’s action will allow those institutions to survive. If the Federal Reserve, the Treasury, and (now) the G7 did not act, the average American would face economic ruin. Ultimately, it is all Americans who are being “bailed out.” Class resentment on the left and rigid market ideology on the right prevented too many Americans from understanding what was really at stake.
Similarly, too much of the debate centered on “sticking the taxpayers with the bill” for the folly of bankers. This kind of rhetoric obscures the financial reality of the situation. Real estate asset-backed securities and derivatives purchased under the plan actually contain substantial value. The problem is that the credit market was locked up with fear and distrust, and without a market the value of these assets cannot be measured. These securities, parts of which consist of those notorious “subprime mortgages,” may appear valueless, but they are not. Far from it. If the government holds these so-called instruments to maturity, the great majority of the underlying mortgages will be paid off with interest, eventually turning a nice profit for the government and the taxpayers. In fact, through the combination of the TARP and the infusion of new equity into the banks, the government will not have to wait that long. The credit markets are already unfreezing, and once confidence is fully restored, the “troubled assets” will be sold back into the market. The end result is likely to be similar to what happened with the Resolution Trust Corporation’s and the Federal Deposit Insurance Corporation’s assumption of $600 billion in bad loans from failing S&Ls and banks in the ’80s and ’90s—a net profit for the taxpayer, through prudent management of those assets and resale to the private market. The bottom line here is that only the government is large enough to carry those assets on its balance sheets until the banks, flush with new equity capital, are ready to start establishing reasonable prices for this debt. Moralistic rhetoric about the injustice of the plan obscures these realities.
Political posturing doesn’t help either. At recent congressional hearings, Rep. Henry Waxman (D-Calif.) had a great opportunity to explore how and why the investment bank Lehman Brothers drove itself to collapse. Instead, he indulged himself in berating Richard Fuld, Lehman’s former CEO, about the size of his executive severance, or “golden parachute.” Similarly, hearings on the failure of AIG did not focus sharply on that insurance company’s reckless use of credit default swaps, or on the need to develop transparency in the market for those complicated transactions. Instead, the complaints were about some over-the-top party for company executives at an expensive resort. The image of a few senior managers walking away with tens of millions (that the failed company was contractually obligated to pay) not only enraged the stockholders, but drove many ordinary citizens around the bend. Even Warren Buffett, the Sage of Omaha, recently told TV interviewer Charlie Rose, “I don’t like what’s going on with executive compensation.” But, he added, it is not the time “to give a lecture about that,” when the American economy is like a “body that’s out there having had the heart attack.” It’s also not a time for dopiness and partisan politics. A good example of both was a question asked by New York Democratic Rep. Carolyn Maloney at congressional hearings on Lehman’s collapse. Maloney demanded a “yes or no!” answer from a panel of experts on whether the Republican-led repeal of the Glass-Steagall Act caused the current crisis. (“Yes,” was the answer she expected.) Unfortunately, Maloney did not understand that the Glass-Steagall Act, enacted during the Depression to separate investment banking from commercial banking, actually created the independent investment banks such as Lehman Brothers and Bear Stearns that proved unable to withstand the current crisis, while the Act’s recent repeal enabled the creation of investment-commercial banking amalgams such as JPMorgan Chase and Citigroup, whose strength in deposits supported their investment banking operations when the real-estate downturn arrived. This is why Goldman Sachs and Morgan Stanley are now becoming commercial banks as well as investment banks. In short, the repeal of Glass-Steagall was a good thing.
The need to have someone to condemn diverts attention from the difficult challenges we now face about structural problems in the financial system. In comparison, the post-2001 corporate scandals, such as Enron, seem almost disarmingly simple. Virtually all those failures involved out-and-out fraud. Corporate managers lied about their companies’ true financial condition. Sometimes the lying involved sophisticated accounting fraud, as in the Enron case. Sometimes, as in the Parmalat case, the lying was just, well, lying. Today’s problems are more complex. Most of the criminal fraud—rather than the excessive leverage—has been after the fact. It occurred because people tried to save their skin as their companies were going bankrupt. The FBI, for example, is investigating whether Lehman Brothers presented too rosy a picture of its holdings to potential investors when it was trying to convince another bank to buy it. The SEC and other regulators found that many financial institutions failed to warn their clients of the impending freeze in the auction-rate securities market, even though they knew it was coming. There are ongoing investigations of financial executives who may have dumped their stock before public disclosure of the full extent of their companies’ problems. But none of that bad behavior caused the credit crisis or its consequences. What we need now is hard thinking about systematic failures in risk management, our financial system’s tendency to produce bubbles, and what should be the proper balance between regulation and deferral to the market.
A final note. One of the risks of moralistic denunciation is that it can usually be turned against the speaker himself. The debt binge wasn’t confined to the Masters of the Universe. As we condemn Wall Street, let’s remember that millions of average Americans loaded up on credit-card debt and forgot about saving. Many Americans were willingly suckered by unscrupulous mortgage brokers into buying homes they could not possibly afford. Millions of other Americans used home-equity loans to drain away the equity in their own homes. All this was done on the assumption that the value of U.S. residential real estate would never go down. Funny, that’s the same bet Wall Street made.
Read more: Letters, December 5, 2008