By Mark C. Partridge, Contributing Editor
The failing of AIG, Merrill Lynch, and HBOS over the past week has gripped headlines around the world. These troubles are leading to increased government intervention as officials search desperately for a way to contain the toxic mortgage-backed securities that are infecting even the strongest institutions.
The U.S. government has alternately saved companies deemed too large to fail, let others fall on their swords, before moving back to saving institutions. With markets continuing to fall, the Bush Administration has evidently seen the limitations of addressing the problems of individual firms.
Changing tack, Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke—himself an expert in the 1920s and ‘30s—have sought to address the underlying issue by using at least $700 billion in public funds to buy up the troubled assets from private companies.
With the increasing government action in Washington, many are writing Miltonian economics obituaries. One Republican senator lamented: “The free market for all intents and purposes is dead in America.”
There is certainly a shift towards a more hands-on approach to managing markets; but there are also limits to how far U.S. officials are willing to go. For example, Bush Administration officials were quick to quell calls for limits on executive pay. Also, these more intrusive measures have limited life spans. The most recent plans to buy up securities will run for two years. Similarly, the loans that have been issued to AIG and co. have a two-year span. These plans are meant as a short-term elixir, rather than a long-term regulatory structure.
The need for these extraordinary measures has become increasingly clear as confidence has eroded and the crisis spread into other areas of the economy—both in the U.S. and abroad. One of the major issues with these assets is that many are owned by foreign companies. Thus, Mr. Paulson indicated that these funds would go towards both domestic and foreign financial institutions.
“If a financial institution has business operations in the United States, hires people in the United States, if they are clogged with illiquid assets, they have the same impact on the American people as any other institution,” the Treasury Secretary said on a Sunday morning news program.
The same can be said of American companies operating abroad as well. The current troubles have cost New York 11,000 banking jobs; London’s financial district has suffered to the tune of 20,000 lost jobs. Even China, which has enjoyed growth of at least 10% since 2003, cut interest rates for the first time in years to maintain growth. With economic malaise, inflation, and rising unemployment threatening the U.S. and global economies, it is little surprise that Washington is stepping into the fray.
The result has been more coordinated action between governments. For over a year, central banks around the world have been releasing funds in concert to stabilize markets. Billions in public funds have flooded the market place to keep liquidity afloat. This week has seen regulators in Australia, Canada, Taiwan, United Kingdom, and the U.S. place a moratorium on short-selling, a process by which investors bet that a stock will fall. Many observers believed that speculators and short-sellers artificially drove down the stock prices bringing financial giants to their knees.
The U.S. has long been the Mecca of deregulation and free trade. The Bush Administration is not the group that will dramatically change the country’s economic course. It has rigidly stuck to the principles of tax cuts and a hands-off approach to the market for years—despite eschewing the third pillar: fiscal conservatism. (The most recent plan would require another lifting of the national debt ceiling; this time to $11.3 billion.) Instead of a dramatic shift in ideology, these steps are strongly pragmatic moves to combat a unique challenge.
Free markets have not been killed by this crisis—yet. But its fate is in limbo, and the ultimate result will depend on the decisions of the next president.
