After This Is Over, Nothing Will Be the Same
— by Inya Ivkovic, MA
Last week, in his speech at the White House, President Obama tried to describe his vision of our world in the post-Great Recession era. He talked about “a new foundation for sustained economic growth,” and “a transformation on a scale not seen since the reforms that followed the Great Depression.” Indeed, if and when Obama’s vision becomes reality, our financial systems and economy will undergo fundamental change. But will it be for the better?
There is a context in which President Obama’s words are to be
considered. He couldn’t have come to power at a worse time, having to face the worst economic and financial crisis in decades. So, it is only natural that he has become wary of the free market and what havoc its tendency to indulge in creative destruction can wreak on the world. It’s no surprise either that Obama is leaning more towards stability in contrast to innovation and competition, any free market’s usual trademarks.
In concrete terms, what Obama’s “New Deal” may entail is rather drastic. For example, the Federal Reserve would be allowed to create a regime to regulate the three key elements of any company or market segment’s health — capital, leverage and liquidity. The idea is to ensure through regulation that no firm or market segment with a wrong combination of any of these key elements could threaten to bring down the entire economy ever again.
Additionally, the Treasury could also be given a significant role in helping financial firms in trouble; that is, to be appointed as a conservator or receiver and to act as a stabilizing force before there is ever a need to call on bankruptcy trustees. The purpose is to send a clear signal to the market that certain financial institutions are simply too big to be allowed to fall. This, in turn, should offer enough of a confidence vote that there is a safety net underneath such institutions and that it is okay to continue trading with, and lend to, them, even as credit and overall conditions deteriorate.
So, what are we really talking about? In no uncertain terms, we are talking about large financial firms — insurers, securities firms, lenders, even hedge funds — essentially becoming government-sponsored entities, much like Fannie Mae and Freddie Mac already have. While this added level of credit default risk protection has its benefits, the downside is that such a policy could deliver the kiss of death to free competition. Large firms would be labeled as government-backed frontrunners, while smaller companies may find themselves squeezed out of the market.
There is more. President Obama also wants to introduce an automatic bailout program for large financial firms, so that they could literally never fail. One of the arguments brought forth to defend this proposal is the failure of Lehman Brothers. Granted, many market participants and analysts, including Warren Buffett, believed that, when Lehman failed, the entire economy was perhaps only hours away from self-annihilation. That sure is something not easily forgotten. But, without risk takers like Lehman, could Obama also be taking the wind out of our economy’s sails? Probably, although, in all honesty, I cannot really blame Obama for wanting to minimize excessive risk taking and consequences if things go wrong.
Why was Lehman’s failure such a turning point? Before Lehman collapsed, Bear Stearns was rescued, so the market expected Lehman would be rescued, too. But when that didn’t happen, market participants had to scrap their existing risk matrices and recalibrate their risk-management systems. The end result was the lending freeze and cash conservation. Lehman’s failure itself didn’t generate obscene losses; the firm was sold off within two weeks of its bankruptcy filing. But what was perhaps irretrievably lost was confidence in the market’s resilience in the face of adversity.
I am not sure yet what to think about these policy changes: there are arguments swinging both ways. What bothers me, however, is the appearance of double standards. When it comes to proposing financial sector policies, the underlying assumption is that the market cannot be trusted. Yet, when it comes to, for example, the auto sector, the market’s good judgment had essentially been ignored. Take General Motors and Chrysler, for example, both of which failed in the market place because Americans no longer wanted to buy their cars. Regardless, the government was there with huge handouts at taxpayers’ expense in one hand and a judicial gavel in the other, ready and able to overturn the market’s sensible ruling.
Last week, the President said, “I’ve always been a strong believer in the power of the free market.” Yet, it doesn’t feel that way and, if and when new policies are passed, the market may never be free again. Just ask Fannie Mae, Freddie Mac, AIG, GM and Chrysler how much freedom they foresee for themselves down the road. Right now, I’m sure their goggles only see a market that cannot change, a market that will eventually see its muscles atrophy because all the thinking and all the work is being done by someone else — its government.