26 March 2010
Three years after the global financial crisis began is as good a time as any to take stock of the US policy response to the fallout from the subprime catastrophe—and assess the response’s effectiveness in nursing the world’s largest economy back to health.
One of the fiercest critics of recent US economic policy is the Nobel prize-winning economist Joseph Stiglitz. In his book Freefall: America, Free Markets, and the Sinking of the World Economy, he lambasts the bank rescue plan, the brainchild of ex-Treasury secretary Henry “Hank” Paulson and Federal Reserve chairman Ben Bernanke, as wholly misguided. Stiglitz called it “among the most costly mistakes of any government at any time.”
The Columbia University professor also accuses US policymakers, including Paulson’s successor Tim Geithner, of being incompetent and in the thrall of Wall Street. Stiglitz said that Obama had chosen to “muddle through” and rearrange “the deck chairs on the Titanic” rather than address fundamental flaws in the US financial system (although, to be fair, Freefall was published before Obama introduced the “Volcker rule,” which, if it becomes law, would bar deposit-taking institutions from indulging in proprietary trading, hedge funds and private equity).
Stiglitz believes Obama underestimated the severity of the economic downturn and the likely level of US unemployment, which caused the president to introduce a stimulus package that was weaker than what was required. The result? Stiglitz said that Obama has condemned the US to lower growth and a more precarious recovery than would otherwise have been possible, lumbered it with a debt pile bigger than necessary and entrenched a deeply uncompetitive financial sector.
This is strong stuff but Stiglitz’s views are by no means universal. Among commentators who are positive about the bailouts and the stimulus is Howard Gold, executive editor of MoneyShow.com.
In “Face it, the government saved us,” a comment piece published in MarketWatch.com, Gold praised the US government’s controversial troubled assets relief program (TARP) and economic stimulus plan, the Fed’s interest rate cuts and flooding of the system with liquidity. Without such measures, he argued the US economy would be in worse shape than currently and that unemployment would be higher than the current level of 9.7%.
Gold wrote: “The more I look at it, the more I conclude that the government actually did its job in preventing apocalypse and helping spur an economic recovery. Policymakers certainly could have done some things a lot better. But without the moves they made, the financial system may have collapsed and unemployment would be far worse than it is now. The people you love to hate—Federal Reserve chairman Ben Bernanke, Treasury secretaries Hank Paulson and Timothy Geithner, and Presidents Bush and Obama—may actually deserve a few words of praise.”
Gold cites a recent survey from the Rupert Murdoch-owned Wall Street Journal which suggested that the US unemployment rate would currently be 10.4% instead of 9.7% had it not been for the government’s rescue measures. Thirty-eight of the 54 surveyed economists said the American Recovery and Reinvestment Act had boosted growth and mitigated job losses, while six said the legislation had a net negative effect. The consensus was the measures had lifted 2009 growth by one percentage point and the economists’ average forecast for US growth in 2010 was 3%, versus 2.2% in the absence of the stimulus. The actions of the US Federal Reserve in pumping liquidity into the system—including cutting short-term interest rates to zero and buying nearly $2 trillion in debt—have played an even more critical part.
Gold also pointed out that TARP will probably cost significantly less than the $700 billion reluctantly authorized by Congress in 2008, and possibly less than $200bn. Gold said: “The bottom line: The government’s actions saved the economy and the financial markets at a cost much lower than many of us feared.”
While Gold’s arguments and the views of these polled economists definitely merit attention, I personally am more on the side of Stiglitz.
The US government’s measures worked, in as much as they averted an apocalypse. But they are not risk-free. By propping up failed institutions, by pumping humongous amounts of liquidity into what remains a dysfunctional financial system and by holding interest rates too low for an extended period of time, they may be storing up unknown trouble for the future. In fact, there’s a danger that they have more in common with sticking an Elastoplast over a mortal wound than giving the patient a thorough medical check-up and prescribing behavioural change.
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