Recent postcards from the financial edge: A bleary-eyed Treasury secretary announcing on a Sunday evening that the government would bail out Fannie Mae and Freddie Mac if need be. The next day, in Southern California, long lines of depositors waiting to withdraw their money from a failed savings and loan.
Secretary Henry Paulson’s appearance on July 13 marked the second time this year that top federal officials scrambled through the weekend to avert a feared Monday morning meltdown in the financial markets. In March, the Federal Reserve used its emergency powers - and tens of billions of dollars in taxpayer-backed guarantees - to prevent the bankruptcy of Bear Stearns and to shore up other major Wall Street firms.
The Fed’s first intervention calmed the markets for a while, and it appears that Treasury’s intervention on behalf of Fannie and Freddie, the mortgage giants, may do the same. The cold reality, however, is that the financial system will be crisis prone and the economy will be weak until house prices stop falling and the mortgage losses are all accounted for. That will not happen soon.
In the meantime, a crisis could derail the markets and the economy.
The worst would be a disorderly decline in the dollar, which would cause prices and interest rates to spike, and could result from a loss of investor faith in policy makers to rectify - or even muddle through - the current problems. At best, the deteriorating condition of the financial system will constrain lending and hurt the economy for a long time.
And that brings to mind the other image of depositors queuing up outside IndyMac Bank branches throughout Southern California. IndyMac, one of the nation’s largest savings and loans, had been seized by federal regulators the week before, the biggest such failure in more than two decades. It was one of just a handful of seizures so far this year, but surely not the last.
As real estate loans continue to sour and as rising unemployment and rising prices provoke defaults across an array of other loans, analysts expect up to 150 banks to fail in the next year or so. That, in turn, could force the Federal Deposit Insurance Corporation, which insures depositors’ money up to $100,000, to raise more money from surviving banks to replenish its $53 billion reimbursement fund; the IndyMac failure alone could take up to 15 percent of the F.D.I.C.’s fund. The potential need to raise money does not call into question the soundness of that safety net, but it is indicative of the challenges that confront both banks and policy makers.
In the short run, Congress should grant the Treasury the authority it seeks to bail out Fannie and Freddie if necessary, by including the proposed measures in the pending foreclosure relief bill. That bill is an essential attempt to stop spiraling house price declines.
Lawmakers are correct to question the Treasury’s plan; it would represent a hasty extension of government powers and could put taxpayers at risk. But they need to resolve their worries, by suggesting alternatives or compromises, rather than wasting time by speaking out about the evils of bailouts to appeal to voters. No one ever wants a bailout. The question is whether there is a better idea than the Treasury plan to prevent the even greater harm that would result from the failure of Fannie or Freddie. Doing nothing is not an option.
It is not enough, either, to focus only on the short run. Today’s financial crises were years in the making, as Americans, awash in tax cuts and easy money, lived beyond their means to an unprecedented degree, and the Bush administration, while cutting taxes, pursued wars and vast new spending. The next president must level with the people, explaining that bolstered savings, by individuals and by government, will involve sacrifice in order to build a better foundation for the future.
The message is complicated. The economy, in the near term, needs stimulus, interventions and perhaps bailouts. But at the same time, the nation must prepare for slow, steady and painful changes to get the economy back on track for the long haul. That means tax increases and government spending cuts, as soon as a break in the economic clouds indicate it is safe to enact them - not only to restore fiscal health, but to channel resources toward neglected areas, like universal health care and infrastructure repair.
What the candidates say about fixing the immediate problems is largely theoretical. But it is not theoretical for them to talk about what they would do, over four to eight years in office, to restore true economic stability.