The Bush administration, long known for faith-based initiatives, has embraced a new form of faith-based economics to address the financial crisis and cascading recession: Weâ€™ll call it an economic version of Christian Science, prescribing modest steps to make the patient comfortable while largely leaving us to heal ourselves.
Itâ€™s only an analogy, but play along. A succession of debilitating infections has left the American economy in critical condition. The specialists (the Treasury and Fed) have prescribed the application of salves (the bailouts) wherever the infections break through the skin (financial institutions facing bankruptcy), while the actual infections (rising home foreclosures, lax or absent regulation, and the credit freeze) are left to heal themselves. As the patient deteriorates, the family (Congress and the White House) faithfully hang on every word from the specialists; and like everything in modern medicine, the price tag is astronomical. Months into this regimen, the treatments have done little to control the infections, and the patientâ€™s condition is critical.
The current regimen also leaves the economy vulnerable to new shocks to its system, and theyâ€™re almost certainly coming. Lucky for everybody, this patient canâ€™t pass away â€” but the economy could require life support for another year and come out of this with long-term disabilities. This weekâ€™s shock came from Bernard Madoff and his accomplices. In normal times, the banks and other institutions that gave Madoff tens of billions of dollars to invest would write down the losses with modest effects on their other activities. Or, if the bailout regimen had included serious measures to stem the housing foreclosures still eroding the value of mortgage-backed securities, the institutions could better absorb the new Madoff losses. But more than half-year into this crisis, the Drs. Bush, Paulson, and Bernanke have still left hundreds of large banks and funds exposed to additional rounds of mortgage-backed-security losses, and thus all the more vulnerable to unexpected losses from sources like Madoffâ€™s schemes. Itâ€™s not too late for Congress to address the underlying infection here, with a 90-day moratorium on foreclosures, and a commitment by Fannie Mae, Freddie Mac and the institutions collecting taxpayer bailout money to renegotiate the terms of the distressed mortgages they hold.
The Great Recession weâ€™re all living through will inflict additional, damaging shocks on the economy. For example, the budget deficit is growing at a record pace, fueled by the accelerating decline and stimulus packages that include virtually every idea any member of Congress has considered over the last decade. The new catch is that as the effects of the economic decline spread to the countries which finance most of our deficits, especially China and Japan, the global pool of savings is contacting. On top of that, the recession has taken hold in much of Europe, driving up their deficits. The inevitable result will be intense competition next year for a shrinking global savings pool, which in turn will put upward pressure on our interest rates in the midst of deep recession. And that will further slow the resumption of normal lending â€” because, once again, the bailout regimen simply applied a salve of taxpayer infusions for financial institutions without addressing their dogged resistance to using those funds to resume normal lending.
The good news in all of this is that the nations that regularly make trouble for the U.S. â€” Russia, Iran, and Venezuela â€” all find themselves in terrible straits. The global recession has driven down their oil revenues (and the value of their government bonds) faster than an American 401K. Unfortunately, as Harvardâ€™s Ricardo Hausmann points out, the global crisis also is cutting off foreign capital flows to most developing nations, including stable and friendly places such as Mexico, South Africa, Turkey, Brazil, and Malaysia. President Obama may well find Vladimir Putin and Hugo Chavez much weakened adversaries. But he and Secretary of State Clinton could well also face new problems triggered by economic upheavals in many parts of the developing world. The silver lining for us is that much of the capital that would have gone to developing countries will flow here instead, hopefully moderating the upward pressures on interest rates. In order to take advantage of it, however, Congress will have to go beyond the administrationâ€™s salves and attach explicit lending requirements to the next round of bailout funds.
The current regimen of Christian Science economics is working no better in this financial crisis than the medical version would work in a deadly epidemic. The American economy will not get well on its own. Fortunately, however, the architects of this approach will retire in a month, and the country then can turn to more able doctors.