Scott BresslerIf the financial turmoil of the past few months taught us anything, it is this: government matters.
In a strong rebuke to libertarian economists and ideologues on the right, our government has demonstrated its role as the foundation of all-market action. Whereas rich bankers and their political puppets clamored for government withdrawal from economic life-“Privatization! No regulation! No taxes!”-these same figures now find themselves being saved by it.
Andrew Ross Sorkin, a business writer for the New York Times, states it best: “Adam Smith’s invisible hand has a puppeteer: the Federal Reserve.”
As most people have pointed out, we do not fully comprehend exactly what transpired in the previous months, so I am not ready to judge the Federal Reserve and our government on the quality of their intervention.
I am not writing to eviscerate President Bush for supporting a bail out of Wall Street but then arguing against interfering with individuals’ mortgages. I am not writing to warn about moral hazard (where people increase their risky behavior knowing they will be bailed out) and I am not writing to lambaste Wall Street for its arrogance, hubris, na’veté, ahistoricism, brashness or stupidity. (I assume bankers are too smart to actually believe their own drivel.)
Though all of these are valid points, my point is that the health of any economic system depends directly on benevolent government intervention.
Here is a brief summary of the events to which I refer.
Americans have enjoyed historically low interest rates throughout this decade, prompting a golden age of corporate profits and a housing boom. Thanks to financial illusions, good marketing and a consumer ethos, millions of Americans were pushed into homes they could only afford if the value of those homes continued to rise. The mortgages on these homes are known as “sub-prime loans,” and they were bundled with other financial products into collateralized debt obligations (CDOs).
People thought these loans were safe because ratings agencies gave them the lowest risk ratings possible. Everyone was happy: marginal people got homes and bankers collected huge fees.
Since these mortgages went to marginal customers, not everyone could pay them and defaults increased as house values started to fall. This basically started in the summer of 2007, and panic ensued as bankers realized they did not know the actual value or safety of those loans.
As loan defaults increased, bankers realized that these CDOs were spread everywhere, so everyone, whether involved with hedge funds, investment banks or brokerages stood to lose an unknown amount of money.
These “known” unknown losses have caused bankers to fear giving new loans, which led to the “credit crunch” we always hear about.
It even caused one firm, Bear Stearns, to collapse when its clients feared it did not have enough collateral and started demanding their investments back.
The Federal Reserve and (to a lesser extent) the Treasury Department have been proactive in stemming this financial crisis.
Since October 2007, they have aggressively lowered the key interest rate to its lowest point in years; offered to exchange $400 billion of Treasury securities, considered one of the safest investments in the world, for the risky mortgages; and it both orchestrated JP Morgan’s acquisition of Bear Stearns and provided $30 billion of collateral to facilitate the deal.
In other words, our government has directly interfered with the operation of financial markets, a fact President Bush acknowledged and supported at the March 14 meeting of the Economic Club of New York.
I have mixed feelings about these actions: they have temporarily calmed markets, but the Federal Reserve will soon want for tools if it continues to rely on them.
It is too soon to know whether Ben Bernanke, the Federal Reserve chairman and a student of the Depression, has saved the day.
My point is that the belief in a free market is a politically expedient ideology abandoned at the earliest convenience.
Free-marketers’ rhetoric revolves around mythological keywords such as fairness, efficiency, meritocracy or equality, but this most recent panic reveals that year-end bonuses and second homes are the real motivators.
Henry Paulson, the Secretary of Treasury who has been instrumental in these Wall Street rescues, reveals the tension in this rhetoric when he says, “People who speculated and bought investment properties in hot markets should take their losses just like day traders who speculated and bought soaring tech stocks in 2000.” Paulson was the CEO of Goldman Sachs before taking his current job.
Zachary is a senior in Arts & Sciences. He can be reached via e-mail at [email protected].