When Should the Fed Bailout the Economy?
Peter Bernstein, author of such books as Against the Gods: The Remarkable Story of Risk, has an interesting piece in the Sunday NYT, titled, When Should the Fed Crash the Party?.
"In the darkest days of the Depression, Treasury Secretary Andrew W. Mellon, one of the richest men in the United States, opposed any government action to stem the tide of plunging business activity and soaring unemployment. Instead, he urged a policy of supreme indifference.
“Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate,” he said. “It will purge the rottenness out of the system,” he added, and values “will be adjusted, and enterprising people will pick up the wrecks from less competent people.”
John Maynard Keynes, for one, thought that prescriptions like Mellon’s were preposterous. The economist called those who held such views “austere and puritanical souls” who believed that it would “be a victory for the mammon of unrighteousness” if general prosperity were not “subsequently balanced by universal bankruptcy.” Keynes perceived too much good in prosperity to treat it as the enemy, and he revolutionized economic theory to prove his point.
Keynes won the argument, and government intervention to overcome rising unemployment and falling profits has been standard operating procedure forever after. Nevertheless, the debate over intervention is not ancient history. It replays in today’s headlines."
Its an interesting debate, but I read Bernstein as discussing the wrong debate. He is reviewing criticism of the treatment of the problem, namely, the Fed's clean up duties. But there is a debate brewing on preventative measures, also.
What makes this go round somewhat different is that the Fed's intervention was forced large numbers of people who were exceedingly reckless. Even by comparison to LTCM or the S&L crisis, the risk embracement was unusually widespread.
As we have seen, there is a cost to this.
This is more than a question of creative Federal Reserve intervention. Right now, the nation is only beginning a debate on several related issues -- including, ansd perhaps most importantly, regulation versus deregulation. If unrestrained financial engineering can lead to catastrophe requiring massive Fed intervention with great costs to the public (inflation, debt, etc.) than the "re-regulation" of the financial markets is a very likely outcome.
This is an important issue worth watching as the election season progresses . . .
>
Source:
When Should the Fed Crash the Party?
PETER L. BERNSTEIN
NYT May 11, 2008
http://www.nytimes.com/2008/05/11/business/11view.html
Sunday, May 11, 2008 | 09:27 AM | Permalink
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They shouldn't because we are going to pay a price for this later. They have given people false confidence.
Imagine if you followed the Fed's false guidence and bought housing or stocks because you believed what they said last year?
All they are trying to do is slow the decent that will occur. That's the purpose of the housing bill they are trying to get through.
With Citibank selling $500B of assets that shows how serious the problem is. Our banks have busted themselves by making bad risky bets.
Posted by: John Borchers | May 11, 2008 9:51:27 AM
I agree with John. Even now we have Jamie Dimon saying its all right.
Anyone notice Brad Setser saying that while we crow about imports falling, notice that exports are falling also?
Posted by: me | May 11, 2008 10:05:37 AM
Keynes won the argument
Shocker that economists came to the conclusion that what was needed was more, better paid and more powerful economists. Who would have thunk that?
Cheers,
prat
Posted by: praetorian | May 11, 2008 10:09:03 AM
It is more disturbing that the two mandatory preceding questions are no longer even being asked.
1. Is government empowered to intervene? For instance, think about the following statement you've heard all the time; "the Fed manages the economy." No, the Federal Reserve Act was last clarried in 1977 as being "to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates."
2. Should government intervene? Not the trivial yes/no type of answer we have come to expect but an honest evaluation of the heavy hand and unintended consequences.
Only then should the third question even be considered; what should be done.
Posted by: Rob Dawg | May 11, 2008 10:30:55 AM
Perhaps we need something a bit more draconian:
If you invest other peoples money with excessive leverage or commit fraud with same then you suffer cap. punishment. Perhaps that would balance the temptation to throw gasoline on the fire After all we are dealing with human nature.
For the sake of argument lets call excessive leverage more than 4 to one, if held overnight or longer.
Perhaps that might give pause.
Posted by: alexd | May 11, 2008 10:40:27 AM
The above applies to the managment of other people's money.
Posted by: alexd | May 11, 2008 10:42:08 AM
Excellent debate!
What a sham ... "Free Markets". Let's call it that until the crap hits the fan. Then we'll bailout Bear Stearns, have emergency rate cuts (10 mins prior to the markets opening), open the lending window to reckless banks. And all this done to protect the people/institutions that created this mess.
What's next ... Is the Fed gonna come in and backstop the deal for Bank of America to purchase Countrywide ... and what's to stop B of A from demanding it. After all, the FED has established the moral hazard.
YES ... our economy needs to purge.
Posted by: Donny | May 11, 2008 10:54:23 AM
Just below Bernstein's piece is Lim's weekly column on whether the "rally is real". Setting aside for a moment the issue of whether such a small, brief move in stock prices is even worthy of such parsing, the more interesting "disconnect" is the difference between the endless data points, semantics, academic arguments, etc. on the one hand, and the way pundits (bullish *AND* bearish) both go long stocks to make money through it all. e.g. A few days ago, there was a blurb somewhere about Honeywell, so BR takes the opportunity to mention that he's been long the name for years, selling only very recently. Yeah, yeah, I know that BR is no Fleckenstein. He's not going to swear off buying stocks out of some ignorant, demented grudge against Alan Greenspan or something. And I'm in no way saying that BR doesn't understand that opportunities still exist even in bear markets. But Honeywell? It really calls in to question the value of the endless pedantic bickering about the vast sea of data points. That BR would spend so much time mining for bearish, gloomy interviews and graphs only to mention that he's been a long-term holder of Honeywell all this time reminds me of that scene in Seinfeld when Elaine is telling her coworker what a bad seed George is. Elaine: "Oh trust me. He's a bad seed. He's a horrible seed. He's one of the worst seeds I've ever seen!" Anna: "And you two are friends?" Elaine: "Oh yeah, we're good friends." The fact of the matter is that BR made a heck of a lot higher percent return on his HON investment than nearly all of the big-time bears have made on their downside bets over the past 4-5 years. Look, if you think Citigroup is pathetic, then don't buy Citigroup. If you think Pulte's goose is cooked, then don't buy Pulte. But if BR telling us that he's been a long-term holder of Honeywell is what we hear in the midst of the worst ______ since the Great Depression, then it makes so much of the CNBC, blogs, graphs, shouting, definitions, wagers, etc. seem like a sideshow to the real thing --- finding stocks to go long.
Posted by: Eric | May 11, 2008 11:08:22 AM
How can the Fed fix the problem when it is part of the problem?
Kevin Phillips talks about the problem and the BS data that Fed keeps feeding the American people. Fabulous interview....
http://www.youtube.com/watch?v=xIoEU1yK1_c
Posted by: Phil | May 11, 2008 12:06:19 PM
how about this question:
"When should the fed KILL the economy?"
Volcker killed the economy, and it led to spectacular long term results.
the fed should have the authority to go both ways. it should punish people when they screw up, and reward them when they do well. that's how capitalism works.
too often they do the opposite.
Posted by: m3 | May 11, 2008 12:26:31 PM
CANCER: Cancer is uncontrolled growth. Beirut would be a geo-political example. As
a conduit of trade & travel between Europe and the Middle East it grew large. Then
in the ~60's jet travel & transport forced it's long & violent collapse into chaos,
as it's reason for existance faded away...And so it is with the USA. We've fed (too much?) unsustainable growth and have (metaphorical) cancer too.
Posted by: dave54 | May 11, 2008 12:28:15 PM
I think Peter Bernstein offers us a deliberate distortion of the historical record. He asserts that Andrew Mellon "opposed any government action to stem the tide of plunging business activity and soaring unemployment."
Mellon, however, certainly didn't seem to have any reservations about bailing out the banks and big corporations, that is as long as it was done with somebody else's money. As Frederick Lewis Allen points out in "Since Yesterday:"
"Again Hoover acted, and again his action was financial. Something must be done to save the American banking system, and the bankers were not doing it; the spirit of the day was sauve qui peut. Hoover called fifteen of the overlords of the banking world to a secret evening meeting with him and his financial aides at Secretary Mellon's apartment in Washington, and proposed to them that the strong banks of the country form a credit pool to help the weak ones. When it became clear that this would not suffice--for the strong banks were taking no chances and this pool, the National Credit Corporation, lent almost no money at all--Hoover recommended the formation of a big governmental credit agency, the Reconstruction Finance Corporation, with two billion dollars to lend to banks, railroads, insurance companies."
So Mellon presided over, as Allen puts it, "a banking system dependent upon secret loans."
And then there is the moral question Allen poses as to whether Hoover and Mellon were "acting with a tory heartlessness in permitting financial executives to come to Washington for a corporate dole when men and women on the edge of starvation were denied a personal dole."
He goes on to state that: "What is certain is that at a time of such widespread suffering no democratic government could seem to be aiding the financiers and seem to be simultaneously disregarding the plight of its humbler citizens without losing the confidence of the public."
Now, back to Bernstein. He concludes that "the debate over intervention is not ancient history. It replays in today’s headlines."
But what Bernstein so conspicuously fails to point out is that, just like back in the days of Hoover and Mellon, there was NO debate over intervention to save Wall Street and the big banks. The debate, then and now and always, arises when we start pushing the envelope to help those farther down the feeding chain.
Posted by: DownSouth | May 11, 2008 12:50:44 PM
"FDR's Folly" by Jim Powell argues that FDR's policies merely prolonged the Great Depression. Excellent book.
http://www.amazon.com/FDRs-Folly-Roosevelt-Prolonged-Depression/dp/140005477X/ref=sr_1_1?ie=UTF8&s=books&qid=1210524602&sr=1-1
Love the blog!
Posted by: LudwigVonMises | May 11, 2008 12:58:26 PM
What an incredibly deep subject for Mother's Day - certainly way too deep for our Sidebar Society to think about for long - after all, American Idol comes on in a few mintues.
As in any human concept, the problems occur when the extreme of that idea is indulged. Pure capitalism is not unlike law of the jungle; yet an ideal socialism is impossible due to the vagueries of mankind's nature.
The best we can hope for is imperfect compromise. More regulation is required for the simple reason that deregulation is worse.
Posted by: Winston Munn | May 11, 2008 1:02:49 PM
Long time reader, first time poster.
Just one thought: Where's the
Glass-Stegall Act when we really needed it?
Posted by: Aaron | May 11, 2008 1:26:13 PM
I'm not sure it's a question of when the Fed should crash the party, per se, but that whatever they do, they do it consistently on both the inflation and deflation side of the bubble. That is, their policy needs to be symmetrical.
So if the Fed is content to not prick asset bubbles as they inflate, it needs to have a similar lassiez faire approach now, as it is deflating. Otherwise we risk creating moral hazard.
Posted by: Jeff | May 11, 2008 1:27:11 PM
"When Should the Fed Bailout the Economy?"
I think the question is illogical, I don't think the Fed is capable of bailing out the economy.
The only way that the Fed can bailout anybody is by creating more money, this will increase M3 and therefore create inflation. Any bailout performed by the Fed must always be paid for by (relatively) lower wages. Lower wages in turn reduce consumer demand which causes unemployment. The question really is, should the Fed collapse the economy immediately or let it gradually decline. Whatever the choice, the dominos must fall.
Posted by: Jurgen | May 11, 2008 1:44:03 PM
FDR's Folly" by Jim Powell argues that FDR's policies merely prolonged the Great Depression. Excellent book...
Posted by: LudwigVonMises | May 11, 2008 12:58:26 PM
----
what folly was that???
feeding starving people...
halting the hemorrhaging of gold from us to Great Britain and buying gold above market price by force of law...
providing jobs that private businesses could not...
building infrastructure like grand coolee dam and bridges with the labor of desperate workers who alternatively could have become communists...
Posted by: mock turtle | May 11, 2008 2:21:43 PM
POST-WAR GROWTH ENGINES:
Korean War
Elvis
JFK/MLK/RFK
Beatles/Stones/Zeppelin
Vietnam War
Nervous Nixon...Jimmy Carter
Movie star elected President
Cut worker wages/benefits/pensions
Cut corporate taxes & regulation
Open borders
Off-shore manufacturing base
Stock buy-backs
Low interest rates...borrow/lend
Commercial real-estate boom
Internet
Tech~stock~mania
Clinton rocked & rolled
Sherriff George elected President
War in Middle-East
Lengthen Super-Bowl halftime show
Residential real-estate boom
HARRY POTTER
Earmarks
Pharmaholics subsidizes
Mega-yatchs servicing
NASCAR on HD-TV
Lower dollar/higher exports
Stimulus checks
Microsoft buys...[?]
Elect Obama President
Universal healthcare
Alaska sold back to Russia
Marijuana legalized & taxed
Hyper-Inflation
Adapt to coastal flooding
Aliens from outer-space invade
Posted by: dave54 | May 11, 2008 2:31:06 PM
Nice quotes/point, DownSouth. Good points, mock turtle.
Dave54, don't hold back. What comes next??
Posted by: wunsacon | May 11, 2008 2:48:28 PM
WHAT'S NEXT?
Fed takes more sketchy paper
Great Lakes water piped west
McDonalds switches to soy burgers
Japan buys Hawaii
Posted by: dave54 | May 11, 2008 4:14:34 PM
The Fed should prioritize their mandates, inflation first and full employment second. If that were the case, they would be much more careful bowing to pressure and lowering rates at this time. The European Central Bank is in a better position than the US. Their first and only mandate is controlling inflation and protection of their currency. After all, they have real world experience with hyperinflation. Our Fed seems to be hell-bent on heading us down that path, although we're only in the 2nd or 3rd inning with the raging fires still a few years away.
Posted by: SteveC | May 11, 2008 4:46:27 PM
Bernstein makes another false claim:
"This school favors government intervention on the upside, but wants no part of government action when trouble develops."
Much of this school (anti interventionists) are either explicity or closet gold-standard folks, who would prefer no intervention either way. They don't want the fed spiking the bunch bowl OR taking it away, as they will typically argue that these actions typically make the swings greater than they otherwise would be.
Even classic monetarists would argue that the fed should just be consistent and resistent to much moving at all. Remember Friedman's claim that that the best thing to do would be to just set monetary growth to match long term GDP growth (about 3%) and leave it there.
-btc
Posted by: BelowTheCrowd | May 11, 2008 5:13:23 PM
«The Fed should prioritize their mandates, inflation first and full employment second. If that were the case, they would be much more careful bowing to pressure and lowering rates at this time. The European Central Bank is in a better position than the US. Their first and only mandate is controlling inflation and protection of their currency. After all, they have real world experience with hyperinflation.» The reason for that is that the USA government refuses to do fiscal policy except through the military-industrial complex ("national security keynesianism"), just as the USA government refuses to do legislation in many areas. The results are that the Fed and the Supreme Court have to step in with monetary policy and Constitutional policy as "technical" bodies which however do a lot of not-so-hidden politics because USA national politics are gridlock. USA national politics are gridlocked because the South was defeated but did not accept the defeat, and are still waging a guerrilla war against the yankees, and the West allies with the South or the North but only to pursue their own interests, and to keep both weak so that the West can do as they damn please. So the great socialization of the involvency of the investment banks (done leaving all the scoundrels in place to continue tunneling as hard as they can) is done by the Fed because this Dixie administration cannot bear to use fiscal means even to save their generous sponsors (and to fool the loser voters as to whom is paying for recharging the great Wall Street Bonus Machine), and so on.
Posted by: Blissex | May 11, 2008 5:33:37 PM
Some people think both Roosevelt's had the wisdom of the old aristos who know it is better to intervene and keep the villagers from suffering too much so they don't get the pitchforks and torches out and start burning and looting.
The parvenue Mellon, as with most parvenues, did not understand this and probably thought non intervention along with private security forces would be sufficient for the day.
Same discussion and issue going on today. All the free marketeer non interventionist parvenues out there who lost nothing on the deal probably think a good Blackwater security contract will be enough no matter how bad it gets down in the village.
Of course those who lost any money would take compensation from whomever, even the evil government.
And of course, America is a classless society so all of the above is nonsense.
Posted by: John | May 11, 2008 5:44:53 PM
