The Rearview Mirror
Craig Barrett, chairman of the board of Intel
First all the headlines, political debates and government actions were centered on the Wall Street "financial rescue package" (it seems that it is not "politically correct" to refer to a "bailout"). Then Detroit came looking for $25 billion in government-guaranteed loans to retool for more energy-efficient cars. This raises the question of where the Department of Energy has been spending its annual $25 billion budget to fulfill its charter of weaning us from foreign oil—maybe we could just give the department to Detroit and save $25 billion? Next consider the $290 billion Farm Bill and you have to ask if everyone in Washington is looking in the rearview mirror.
Where are our investments for the 21st century? Why can't we get a permanent research-and-development tax credit or fund the America Competes Act, which increases the basic research funding of the National Science Foundation and top universities? I'm afraid the bailout is typical of the current attitude of Washington—prop up old industries and forget about tomorrow. Sure we get great promises in campaigns, but in practice we starve the new ideas. Joseph Schumpeter and Adam Smith, our great free-market theorists, must be rolling over in their graves. Instead of allowing creative destruction we are propping up failures. We need to invest in smart new ideas. I think it goes without saying that the $700 billion bailout is doing exactly the opposite.
Down the Rabbit Hole
Robert Reich, former secretary of Labor under President Clinton, now professor of public policy at University of California, Berkeley
Nine straight months of shrinking employment spells recession. And it's likely to get far worse before it gets better. The problems aren't only found in hobbled credit markets. They're also found in hobbled consumers.
The $700 billion bailout hasn't worked because the Treasury and the Fed have still not fully and convincingly explained how it will be used to restore confidence. Instead, they've issued a hapless and feckless set of policies—letting Lehman go, propping up AIG, creating shotgun marriages between other banks, and now talking about government taking equity stakes in other financial institutions. It looks to all the world as if American policymakers have no idea what they're doing.
At bottom, this isn't a liquidity crisis. It's a crisis of trust. No one's in charge. A lame-duck president commands almost no public trust; a Treasury secretary, who comes from the same culture that got us into this mess, can't explain what happened and what he's doing about it. Lenders of all stripes don't trust borrowers will be able to repay. Every major player is moving to safer ground—holding money, hoarding it, putting it under a giant global mattress.
Now that America is tipping into deeper recession and unemployment is mounting, more bad loans are cropping up because more people can't pay their bills. And as consumers pull in their belts, more businesses can't pay their bills. Which means more layoffs, and more bad loans, and a global sell-off.
For years, regardless of the business cycle, American consumers were the Energizer bunnies of the world economy. Their spending kept it going. But now the Energizer bunnies have turned into scared rabbits, and they're going back into their holes. The global market is less dependent now on American consumers than it was 10 years ago—consumers in China and India and Europe now comprise a significant force—yet Americans remain at the center of global demand. So when American consumers slow down their purchases, the entire world economy slows.
What to do? Trust can be restored only if we have better regulation of Wall Street in order to avoid the sort of bubbles and Ponzi-like schemes that have generated this credit crisis.
But we also need to get money back into the pockets of average American consumers. That means major public investments in job- creating infrastructure and affordable health care, as well as a more progressive tax code.
There Never Was a Plan
Allan Meltzer, professor of political economy at Carnegie Mellon and visiting scholar at the American Enterprise Institute
The principal problem with the $700 Billion Paulson plan was that there was never a plan. Proponents were unable to explain how the plan would work or why it would work. Instead of developing a plan, they spread fear and anxiety to gain public support, talking up Depression, job losses, and employers unable to pay wages. A falling stock market heightened public concern for pensions.
Alas, the stock market continued to fall after Congress approved the program, not least because the bailout was never supported by an explanation of how buying mortgages would help firms to borrow for payrolls and inventories. Then the Federal Reserve found it necessary to support the commercial paper market, where firms in fact borrow money to finance payrolls, employment, production and inventories. Passing the bailout did not solve that problem.
Democratic governments should never use fear to frighten the public into accepting a program that most knew for what it was—a bailout of the lenders who mismanaged their business. The problem isn't the mortgage market. The mortgage market reflects the problem in housing.
No one can confidently say how far housing prices will fall, and the value of mortgages depends on those prices. The steeper the fall in housing prices, the more homeowners will default. That's the risk that buyers of mortgage bundles have to accept.
Contrary to much public comment, sales of mortgage bundles are still occurring. The low price paid reflects the large risk the buyer accepts. Usually, mortgages sell for less than 50 cents on the dollar of original value. Merrill Lynch sold a big stake for 22 cents on the dollar. Most financial firms that have large holdings would wipe out their capital if they sold at prevailing prices. They expect, or hope, to get a better price from the Treasury.
Promises of future profits for taxpayers are the stuff of dreams. The much simpler bailout of the savings and loans cost the taxpayers $150 billion. That will look small before we finish the mortgage bailout.
How Long Will a Recession Last?
Desmond Lachman, resident fellow, American Enterprise Institute
History will judge American policymakers harshly for their misdiagnosis of the current crisis, which has become the worst in 80 years and may lead to the most severe recession since World War II. More than a year after the beginning of this crisis, both the U.S. Treasury and the Federal Reserve do not fully recognize how much falling home prices and rising foreclosure rates complicate the problems in the financial sector. Worse still, as the markets have been quick to realize, Secretary Paulson's bailout plan only partially addresses the liquidity problems of the financial sector, and does not address its solvency. Inadequately capitalized banks will remain mired in the process of selling assets and will restrict lending to repair their damaged balance sheets. Prices of assets will be driven lower as banks sell, compounding the problem.
The United States is already in a serious recession, and the most recent credit freeze and equity price plunge all but ensure that it will last through 2009, with unemployment rising above 7.5 percent. How long the recession lasts will be determined by the economic policy of the current administration over the next few weeks. The economy will not have a meaningful recovery until the housing market is stabilized and the banking system is adequately recapitalized, two goals that ought to be the first order of business of the next president. He should also consider another stimulus package, and the Federal Reserve should consider more interest-rate cuts.
The rest of the world will not be spared. Europe and Japan are already in recession. Their economies will also continue to be buffeted by falling equity prices, tight global credit, and severe housing busts in Spain and the United Kingdom; and the growth of the emerging-market economies will slow as their overseas markets shrink.
A Possible Solution in Private Equity
Wilbur Ross, chairman of his own private-equity firm, and chairman of AHMSI, the second-largest U.S. servicer of subprime mortgages
The Emergency Economic Stabilization Act ("EESA") may provide $700 billion of liquidity to the financial system, but the liquidity crisis is continuing. Banks have reduced their total lending over the past six months, and are charging other banks unprecedented premiums for overnight borrowing because they are especially wary of bank failures. As of the end of September, banks will have written off at least $150 billion more than the amount of new capital they have raised over the last twelve months. Regulators limit the amount of loans a bank can make to a multiple of its capital in order to provide a cushion for losses. As a rule of thumb, each dollar of loans requires 10 cents of equity. This means that the $150 billion shortfall must constrain lending by $1.5 trillion, or more. The taxpayers' $700 billion fills less than half of the hole. We need another $80 billion, or better yet, $100 billion of equity (not liquidity) simply to bring things back to normal and reopen the credit spigots. Otherwise banks will continue to shrink their lending and exacerbate the problems of sky-high interbank lending rates and declining purchases of commercial paper and other notes that raise cash for businesses and municipalities. The economy cannot grow without liquidity and liquidity cannot grow until banks have enough capital on their books.
There is a solution, and, happily, it requires neither federal funding nor congressional action, only a change in regulations. Private-equity funds have as much as $450 billion they could invest in banks. But under the current rules any private-equity fund that bought a majority of a depository institution would have to sell its other nonfinancial investments. Yet investment banks and depository institutions have been allowed to own each other since the repeal of the Glass-Steagall Act. Why would it be worse for a bank to be owned by a private-equity firm than an investment bank? Private-equity firms have long and proven track records of recruiting good management for their portfolio companies. Some argue that new management would vanish should the fund sell, but in fact, recent history in other countries shows that this is not so. Private-equity firms like mine and others have already helped Japan, Korea and Germany resolve banking crises by purchasing and rehabilitating failed banks.
The Federal Reserve has begun to allow private-equity funds to buy more of a bank without tripping the ownership wire. Let us hope for further action along those lines. Private investment is a better solution than the undesirable alternative of risking tens of billions of dollars of taxpayers' funds.
Time to Bet on the Consumer
Susan Sterne, chief economist, Economic Analysis Associates
It might well be time to bet on the consumer.net consumer borrowing has already dropped 80 percent since last year and it rarely goes negative. Energy prices have come down, and so has the cost of food. Home prices have become more stable in some regions. Despite panic on Wall Street and hurricanes elsewhere, consumer sentiment is positive. To reduce the cost of living, consumers have been trading down but now that prices are slowing, they can buy again. In the second half of next year, we would expect to see a rebound in car sales and housing. This rebound could be stronger than it was in the last cycle, in 2001, which was not preceded by much of a decline. We are also coming out of a period with the most modest job gains in history, so it isn't unreasonable to expect job losses to be muted as well. In fact, the recent spike in the unemployment rate was not so much caused by lost jobs as by an increase in workers, which is common during a recovery. During the early stages of any recovery, workers sense opportunity and return to the labor force long before most of us realize the environment has improved, reinforcing the adage that by the time everyone realizes we are in recession, it is over.