No Democracy will Allow its Economy to Implode 

By Bill Frenzel 

Our credit markets are in shambles.  Few Americans comprehend the reasons for the system’s failure, but nearly everybody understands that it is “broke.”  Ironically, a country renowned for devotion to free markets now seems to require the government to “save” those markets.  

The Bush Administration, led by the Secretary of the Treasury and the Chairman of the Federal Reserve Board, is asking Congress to enact a $700 billion rescue plan.  There is heavy resistance.  But, after much complaint and criticism, and the addition of its own “improvements,” Congress will probably agree to some version of the proposal. 

Purists and populists alike bewail the plan.  A government solution is usually a wrong solution.  The greedy risk-takers should not be protected.  Every other loser in the country will insist on salvation, too.  Even those who have lost nothing will demand much.  

Whenever the government meddles in the marketplace, whether in crisis or to respond to criminal behavior, it tends to go too far.  There is always an urge to overdo the relief, or to reward an unworthy class, or to lay on too much burdensome regulation. 

The critics, many of them conservatives, are dead right.  A free market system should require that mistakes be corrected, and paid for, in the marketplace.  The problem is, however, that no democracy will allow its government to stand idly by while its economy implodes.  Most people would devoutly hope that the government would not have to intervene.  But when the panic strikes, the people can usually be counted upon to demand government interference. 

A basic question policy-makers need to ask and answer is this: How bad is it?  If the crisis can be weathered without major damage to the economy, the urge to meddle should be restrained.  

Cases for restraint would include the Chrysler and New York City loans of the 1970s, specific industry requests like the current auto industry loans, and the never-ending demands for protectionism.  The economy can withstand the loss of a couple of big companies which made mistakes.                                                                                                                                  

But when the whole financial system begins to crumble, the government is driven to respond.  Failure to act means punishing everybody, probably for a very long time, until the system is rebuilt.  

Another basic question: Whose rescue plan is to be used?  When the government is poised to meddle, the time-tested rule is don’t let Congress lead.  If the Executive Branch does not lead, Congress will.  With Congress in charge, the rescue becomes a bidding match to shower benefits on favored constituencies.  Everybody gets paid off with someone else’s money.   

The good news here is that there are some successful modern precedents.  Two of them are Long-Term Capital Management and Continental Illinois Bank.  Those rescues were swift and successful.  The system was protected and the economy hardly burped. 

More to the point is the case of the Resolution Trust Corporation, a five-year rescue operation of the early 1990s.  Savings and loan firms were beginning to fail in significant numbers.  The financial system appeared to be at risk. 

RTC was successful.  Its operations shored up the system.  Many S & Ls failed, but most survived.  Best of all, RTC left the taxpayers about as well off as they were before its creation.  Its success, and reductions from Cold War Defense spending levels, helped put the U.S. budget in the black in the mid-‘90s.  

No two crises are the same.  The S & L meltdown, we are told, was only half as difficult as today’s problem.  Different situations require different solutions.  No one can be sure that the Paulson-Bernanke rescue plan will work like the RTC did, but experts assure us the problem is serious.  

So how does this free marketeer react to the Paulson-Bernanke rescue operation?  He wishes that they had not been obliged to propose it.  He is grateful that they waited long enough to be sure the crisis was real.  Believing that it is, he is equally grateful that they have finally moved toward a solution they believe is adequate.    

He prefers an executive branch plan over a legislative branch plan, and  hopes Congress does not “water up” the administration’s proposal by adding pay-offs for favored constituencies.  Or, more realistically, he hopes congressional add-on costs and regulations can be limited in scope. 

Finally, he hopes that our fabulously successful market system will infrequently require future interventions and that the marketplace will be able to exact its own punishment for incompetence and greed. 

He has regrets but no illusions about government intervention into the private marketplace.  It will happen again, and often.  We simply have to do our best to manage it carefully.  

Bill Frenzel is a guest scholar at the Brookings Institution and a former Member of Congress from Minnesota who voted against federal loans to Chrysler and New York City in the 1970s.