Slouching Toward Sanity

BERKELEY – In America today – and in the rest of the world – economic-policy centrists are being squeezed. The Economic Policy Institute reports a poll showing that Americans overwhelmingly believe that the economic policies of the past year have greatly enriched the bankers of Midtown Manhattan and London’s Canary Wharf (they really aren’t concentrated along Wall Street or in the City of London anymore).

In America, the Republican congressional caucus is just saying no: no to short-term deficit spending to put people to work, no to supporting the banking system, and no to increased government oversight or ownership of financial entities. And the banks themselves are back to business-as-usual: anxious to block any financial-sector reform and trusting congressmen eager for campaign contributions to delay and disrupt the legislative process.

I do not claim that policy in recent years has been ideal. If I had been running things 13 months ago, the United States Treasury and Federal Reserve would have let Lehman and AIG fail – but I would have discounted their debt for cash at face value, provided that the debt also came with sufficient equity warrants. That would have preserved the functioning of the system while severely punishing the banking and shadow-banking systems’ equity holders, and today nobody would be claiming that their risk management practices were adequate and did not need reform.

If I had been running things 19 months ago, I would have nationalized Fannie Mae and Freddie Mac and for the duration of the crisis shifted monetary and financial policy from targeting the Federal Funds rate to targeting the price of mortgages. Ever since 1825, the purpose of monetary policy in a crisis has been to support asset prices to prevent the financial markets from sending to the real economy the price signal that it is time for mass unemployment. Nationalizing Fannie and Freddie, and using them to peg the price of mortgages, would have been the cleanest and easiest way to accomplish that.