Monday, September 22, 2008
The Smart Money
"If all else fails," John Kenneth Galbraith wrote, " immortality can always be assured by spectacular error." From a Galbraithian perspective, the present Titans of Wall Street have achieved both immortality and infamy.
Their errors, wrote Robert S. Samuelson last week in The Washington Post, were essentially three: "First financial firms have moved beyond their traditional roles as advisers and intermediaries." Instead of counselling investors, they have become aggressive players in the market, placing their own bets on winners and losers. "Second, Wall Street's compensation is heavily skewed towards annual bonuses." That compensation system has encouraged a short term focus on the next quarter or, at most, the end of the year. The long range health of the institution the Titans serve has disappeared from the corporate radar screen. And "finally, investment banks rely heavily on borrowed money, called 'leverage' in financial lingo." In the case of Fannie Mae and Freddie Mac, the "leverage ratio" exceeded 60:1.
Anyone who goes to the track and puts down a two dollar bet on a horse running 60 to 1 is a romantic. Someone who bets millions on the same horse is certifiable. But the movers and shakers at the big firms convinced themselves they had gamed the system and squeezed the risk out of it. By spreading that risk to hundreds of thousands of ordinary folks around the globe, they believed they had inoculated themselves against failure. What they did not count on was the horse coming up lame. And, as the Titans discovered that tens of thousands of people could no longer afford the houses they lived in, all those interest payments supporting their own house of cards dried up -- at the same time. When people cannot pay their debts, their lines of credit are cancelled.
What the American government now proposes is to take all those bad bets off the table and to revisit them at a more propitious time, or -- if that time is a long time coming -- to let American taxpayers cover them. Such a solution allows the high rollers to exit with the shirts on their backs. But the real question is, will the home owners also be covered? Will they keep the roofs over their heads?
In 1936 Franklin Roosevelt explained the crisis he faced this way: "Private enterprise, indeed, became too private. It became privileged enterprise not free enterprise. Freedom," he declared,"is no half and half affair. If the average citizen is guaranteed equal opportunity in the polling place, he must have equal opportunity in the marketplace."
For the last three decades, "freedom" has been used as a synonym for "privilege." The rescue package which is currently on the drawing boards is necessary. But, unless ordinary citizens get the same kind of relief being offered the Brahmins of Wall Street, we will only succeed in freeing up credit so people can once again go deeply in debt. The essential illusion of supply side economics is that demand will keep pace with supply. If you increase the supply of goods, you will magically increase the demand for them. During the last thirty years we have let demand keep pace with supply by going more deeply into debt. But last week proved -- beyond a doubt -- that debt has its limits.
Besides taking bad debts off the table -- as Roosevelt did -- the government needs to put money into the hands of ordinary citizens and create essentially a new Works Progress Administration. This would be no mere make-work project. When the bridge across the Mississippi River collapsed two years ago, that tragedy underscored just how badly the nation needs to renew its infrastructure. The retired investment banker Felix Rohatyn -- who helped rescue New York City from bankruptcy thirty years ago -- has suggested that what the United States needs is a National Infrastructure Bank, whose task would be to rebuild the nation's rotting roads, bridges, electrical grid, etc. If they are left neglected, more than Wall Street's house of cards will fall. If they are attended to, lots of people will be able to stay in their homes. To pay for the new program, the government could begin by taxing back some of those executive bonuses. No one needs hundreds of millions of dollars a year to live comfortably.
Last week should have tolled the death knell for supply side economics. Despite all its statistical data and Laffer curves, it has essentially been an excuse for greed. As Galbraith also wrote, "The modern conservative is engaged in one of man's oldest exercises in moral philosophy; that is, the search for a superior moral justification for selfishness."