Time for less talk, more action

The extended Wall Street turmoil resulting from the housing and subprime lending crisis contains major challenges, reinforced by the current media propensity for scare headlines and alarmist editorials.

Political leaders have helped to feed public anxiety.

Optimistic declarations by President George W. Bush conjure up eerie images of the unfortunate President Herbert Hoover, who stressed the economy was "fundamentally strong" even as the greatest economic collapse in modern history was unfolding.

John McCain has skidded between comparable optimism and draconian declarations about firing Securities and Exchange Commission Chairman Christopher Cox, while Barack Obama has said little specific beyond the urgency of removing Republicans from office.

Economic output has slowed this year, and we may have entered a recession, with unemployment now up to just over 6 percent. Pessimists rightly point out that discouraged job seekers have disappeared from the jobless statistics.

A severe sustained Wall Street slump could touch off a severe recession. The collapse of Lehman Brothers and federal bailout of AIG this week, along with Fannie Mae and Freddie Mac earlier, demonstrate the weakness of the investment banking and closely associated mortgage sectors.

Earlier this year, the government facilitated the purchase of bankrupt Bear Stearns by J.P. Morgan Chase, while lowering interest rates. The immediate dramatic upswings on Wall Street after each intervention show global capital remains available for investment, but in a very volatile climate.

The real economic policy challenges we face are very important but also comparatively subtle. First, the Federal Reserve System once controlled the money supply as well as interest rates, but no longer. Since the Second World War, the U.S. dollar has been essentially freely convertible, as part of a very successful basic strategy to encourage global commerce. Farsighted leaders in the Roosevelt and Truman administrations laid the foundation for our enormous long-term world economic success.

A byproduct has been growth of dollar holdings overseas, reducing the influence of the U.S. Fed. No one knows exactly how much of the world dollar supply is directly managed by the Fed, though informed estimates range from 20 percent to one-third. Former Fed Chairman Alan Greenspan’s easy money policies, and celebrity style, tended to mask this fact of life during much of his tenure from 1987-2006. By contrast, throughout the 1950’s Fed Chairman William McChesney Martin remained largely invisible to the American public though extremely powerful.

Second, steady interest-rate cuts over time have diminishing positive effect. The great British economist John Maynard Keynes warned about this phenomenon, which he described as the "liquidity trap." A slowing economy is like a great sailing ship trapped in a calm windless sea. As the interest rate approaches zero, government loses a fundamental tool to spur economic activity. The Fed decision this week to hold rates steady is therefore extremely wise.

Third, strong government regulation, established during the New Deal, is essential. In retrospect, current irresponsibility was fed by abolition in the mid-1970s of fixed brokerage commissions and in the late 1990s of the Glass-Steagall Act, which segregated commercial banking from other financial services.

Fed Chairman Ben Bernanke, a respected student of the Great Depression, has looked to such fresh approaches as lending Fed funds directly to investment banks and a temporary ban on short selling. Treasury Secretary Henry Paulson proposes a new structure comparable to the Resolution Trust Corporation, which handled the savings and loan crisis of the late 1980s. Principal central banks in the world are now coordinating their market moves.

Both McCain and Obama are suddenly emphasizing more regulation, and Congressional leaders in both parties must do the same. Simply bailing out failed financiers will not be enough.


(Arthur I. Cyr is Clausen Distinguished Professor at Carthage College in Wisconsin. He can be reached at acyr(at)carthage.edu)