This article first appeared in the St. Louis Beacon: October 18, 2008 - Washington's intervention in the recent financial meltdown will probably make money for taxpayers, was "elegantly designed" and is in no way a prelude to a second Great Depression, a panel of financial experts said Friday at Washington University.
"I think the government will make money on this," David Kemper, chairman, president and CEO of Commerce Bancshares Inc., told an audience of several hundred students, faculty and guests. "This is a pretty elegantly designed program."
Kemper was referring to the most recent action by the federal government to buy $250 billion in shares of banks large and small to inject liquidity into seemingly frozen credit markets.
How would taxpayers make money?
Since the government will be buying bank shares at low prices, its actions to bring stability to financial markets should benefit the banking sector and therefore raise the value of those shares.
Panelists did not believe the federal government will continue to own shares after markets have righted themselves. So it will sell them, thus making a profit.
The panelists also generally agreed that:
- the current crisis was brought on by failure to follow sound lending practices;
- the Federal Reserve Bank, America's central bank, is acting prudently by forcefully buying bank stocks;
- a market-based solution would take too long and cause too much pain;
- the economy is in for a few rough quarters until consumer confidence is restored;
- but it is not headed into a prolonged depression.
Kemper and four others on the panel said federal action, contrary to widespread complaints that it was a bailout for reckless banking officials who made thousands of bad loans, was necessary to get markets functioning again.
Letting the market sort out and punish the bad actors would not thaw frozen credit, said James Bullard, president and CEO of the Federal Reserve Bank of St. Louis.
"It's too slow. It would take weeks and months," Bullard said. "That's what led to direct capital injection."
Nonetheless, the economy is in for several more quarters of bad performance, said Steven M. Fazzari, associate director of the Weidenbaum Center and professor of economics.
That's because consumers are hanging onto their money, since they may have lost or fear losing their jobs and anticipate that the economy is heading into another depression like the one during the 1930s.
Bullard stated more than once that one should not compare what is happening today to events of the early 1930s, when the U.S. plunged into a depression, with high unemployment, many bank and company failures and an economy that was stalled for several years.
He ticked off ways in which the current situation is different.
For instance, banks didn't fail until 1931, two years after the 1929 stock market crash, while several investment and commercial banks have failed in recent weeks and a precipitous decline in the stock market has already occurred.
In the early 1930s, the Federal Reserve Bank did little to add liquidity to the system, which is the opposite of what the Fed has done this time.
There's no gold standard today, which means the dollar and other key currencies aren't restricted to gold and therefore can expanded as governments see fit.
Bullard also didn't think Congress and this or a future administration would enact high tariffs, like the infamous Smoot-Hawley tariffs that helped to bring trade to a standstill in the 1930s and prolonged the depression.
And Kemper noted that this time around, governments like the United Kingdom and others of industrialized countries have been working together and not at cross purposes, as they did in the 1930s.
Fazzari pointed out that consumer spending drives about 70 percent of the economy, so until consumers feel more confidence in their futures, they are likely to be more conservative in their spending and borrowing, which will be a drag on economic activity.
He said the economy is entering a recession, but in no way will it equal the severity of the Great Depression.
Several panelists explored the causes of the current situation.
Guillermo Ordonez, assistant professor of economics at Yale and a research economist at the Federal Reserve Bank of Minneapolis, lay part of the blame on rating agencies like Standard & Poor's and Moody's Investors Service that analyze risks on securities for financial markets.
"Why did rating agencies overrate these securities?" he asked. "Why did financial institutions decide to take excessive risks?"
Then, answering his own questions, Ordonez said problems like these arise when "the danger of losing one's reputation is very low, or the benefit of taking excessive risk is very high."
"We need to really understand where the self-discipline of the market collapsed," Ordonez said.
Kemper struck a similar note, saying that "we had people throw risk out the window" and exercise very little discipline. He said three factors generally converged to create the situation the economy and financial markets are going through: savings are too low; consumption is too high and people have taken too many financial risks.
Sorting this out and restoring confidence and market discipline will be a very painful cure for many Americans, Kemper added.
Washington's actions of the past several weeks, including supervised mergers of investment banks, Bullard said, mean "many of the key uncertainties have been contained."