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Here are the lessons I learned after reading Fisher’s piece again and reflecting on our current dilemmas from its perspective.
Lesson 1: Fiscal stimulus is a band-aid. We need – now and for the next two years –massive government spending to support the unemployed and prevent the implosion of state and local governments. Beyond that, spending will not stimulate anything, and it has nothing to do with the causes of the crisis or with putting an end to it. It is the strong pain killer that the economy needs for the infection that afflicts it, but it is just a pain killer, not a cure. Well-crafted tax adjustments can be useful, but only if targeted to address the deflationary pressures and/or the fragility of the financial system (see Lesson 2). By the same token, trade protection and other similarly “brilliant” ideas floating around need to be opposed. They will do nothing to attack the causes of the crisis, and they could make the recession deeper and more protracted.
Lesson 2: Deflation must be halted and reversed, and the credit system restarted. Today, as in the early 1930s, these two parts of the puzzle are tightly interrelated, as Fisher explained. Deflation will not stop if the collapse of the credit system is not contained, and the collapse of the credit system will not stop until the deflation of asset and goods prices is controlled. A trillion dollars of fiscal stimulus today will not avoid catastrophe if the financial stabilisation fails. Conversely, the sooner a credible, comprehensive, and effective financial stabilisation plan is implemented, the lower the actual cost of “true” fiscal support needed for the social safety net.
Being realistic, however, even if we had this ideal situation in place tomorrow, a major recession – unlike anything most Americans alive today have ever seen – is unavoidable. Catastrophe is here and we will not escape it. But even the 18-to-24-months catastrophe we are in is not the worst outcome. The worst outcome would be a full repeat of the Great Depression. The worst of the Great Depression was not so much the initial economic collapse, as dramatic as that was, but its persistence for several years. This is what we still have time to avoid and where our energy should be invested. The political spin about pushing for reforms and bailouts to “avert disaster” needs to be corrected, so that everyone’s expectations are not biased towards thinking that a trillion dollars of fiscal stimulus means back to business as usual. The emergency is real and present, but not to escape catastrophe. All the numbers we have about employment, production, world trade, the financial system, etc. show that we are already in a catastrophe. The emergency is to avoid the persistence of the stagnation that occurred during the Depression. The emergency is to prevent most of the next decade from looking like 2008.
Lesson 3: Prevention. We got into this mess because financial development advanced way ahead of not only regulators and government officials, but the actors in financial markets themselves, including the geniuses who created the innovative financial products that we have now come to know (and fear) by their acronyms – CDOs, MBSs, CMOs, and the greatest villain of all, CDSs!
Preventing the next debacle, however, requires careful thinking. Imposing regulations and controls that would return the financial system to its 1960s structure would be a major mistake. The challenge is to identify where things went very wrong and plug the deep holes that exist while preserving the enormous potential that the securitisation of financial assets has for enhancing efficiency and standards of living worldwide. A starting point is to recognise that government made two huge mistakes in (a) directing regulators to ignore products like CDSs, by pretending that simply by an act of law they could be declared not to be standard securities or a form of gambling (both of which they were!), and (b) instituting and enlarging the implicit government guarantee backing the fast expansion of mortgage giants Fannie Mae and Freddie Mac. Had the wisdom of people like Mrs. Brooksley Born prevailed in the late 1990s, the CDS market would have been at least supervised, if not regulated. This alone would have saved us enormous pain today, because the jump from the mid-billions problem that sub-prime mortgages were to the mid-trillions debacle we are suffering occurred largely due to the casino-like setup in which AIG and other financial companies conducted the CDS business. |
