Don't panic over a burst bubble

After the stock market crash of 1929, progressive Republican president Herbert Hoover claimed his long-serving Treasury Secretary Andrew Mellon succinctly advised him to "liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate." He should have listened. Instead Hoover steered huge tax and tariff increases through Congress, flattening his own re-election hopes along with the economy and paving the way for his "pragmatic" successor Franklin Roosevelt to impose an endless bewildering series of ill-advised interventions accompanied by bitterly anti-capitalist rhetoric. It worked so well that 10 years after the crash the United States was still mired in a massive depression.

As Americans ponder whether this is a bad time to panic or the perfect opportunity, it's worth noting that after the earlier catastrophic slump of 1921, Mellon's advice was followed. Instead of kicking the economy when it was down, Republicans let markets sort themselves out, cut taxes, paid down debt and launched a long boom. Some may say the 1920s witnessed false prosperity under laissez-faire. But it's hard to deny that the 1930s witnessed real depression under intervention.

So forget partisan bickering over who's to blame for lack of government oversight of U.S. financial markets. The answer might surprise you, especially John McCain's new ad featuring Bill Clinton blaming the Democrats. But what's the point?

The problem wasn't too little regulation so there's not a lot to be gained by arguing about who wanted more. The root cause of this crisis is the U.S. government massively pumping up mortgage markets ever since the New Deal, piling program upon program to subsidize unsound lending, including Mr. Clinton's own administration putting aggressive political and even legal pressure on Fannie Mae and Freddie Mac to boost subprime markets.

What has now gone wrong is that huge numbers of people have suddenly realized that for decades banks were making loans they should not have approved to people taking out mortgages they could not afford because of guarantees the government should not have given. And no package should pass Congress that doesn't have some rational bearing on this problem.

The right answer is to get rid of those guarantees, not add to them. When you get a "meltdown," panic, recession, correction or whatever name makes you feel better about it, what has happened is not that the economic fundamentals have gotten out of whack but that large numbers of people have noticed they are out of whack. Proposals to "stabilize" financial markets under such circumstances amount to substituting make-believe for honest mistake. Why would you want to do that, and how could you? What you need is to get your financial system back in alignment with people's understanding of what the real assets are worth and the only way to do that is to let the prices of paper assets fall to realistic levels.

Please keep in mind that liquidating the unsound financial structure doesn't destroy real wealth. It doesn't mean going to houses purchased with triply unsound credit and burning them down. They will still be there and, odds are, the same people will still be living in them. Rich people aren't going to move into 10 cheap suburban houses each and put typical American workers into cardboard boxes. The best economic use of modest houses is to house folks of modest means and that's what a tidied-up financial system would do with them.

Panic, by contrast, means throwing good money after bad. All the Bush administration seems to have is the old something-must-be-done, this-is-something, so this-must-be-done argument. Other voices are no more persuasive. For instance a strangely cheery Globe and Mail piece from a British academic proclaimed not only that "the U.S. free-market creed has self-destructed" but that the "era of U.S. global leadership ... is over". Phooey. This bubble had nothing to do with free markets. And left-wing professors have been gloating over the decline of the American empire since at least 1970, when Richard Nixon took the United States off the gold standard amid the Vietnam entanglement, race riots, economic stagnation and a rising Soviet challenge. It's old news and it isn't true.

It also isn't relevant. No amount of government profligacy can make unsound subprime derivatives valuable in any geopolitical context. And Americans seem to know it. Hence the shameless loading of expensive unrelated goodies to the second, Senate, version of the bailout to seduce the surprising number of Congresspersons who heeded Mellon, and voters, the first time around.

Here's hoping they listen again.

[First published in the Ottawa Citizen]

Columns, EconomicsJohn Robson