October 14, 2008
Intervention Is Bold, but Has a Basis in History
By STEVE LOHR
After a week of mounting chaos in financial markets around the globe, the United States took a momentous step that shifts power in the economy toward Washington and away from Wall Street.
The government’s plan to prop up banks large and small — along with recent bailouts as well as guarantees to support business loans, money markets and bank lending — represents the most sweeping government moves into the nation’s financial markets since the Great Depression, and perhaps ever, according to economists and finance experts.
The high-stakes program is intended to halt the worst financial crisis since the 1930s. If successful, it could long be studied by historians as a textbook case of the emergency role that government can play to rescue a teetering economy.
“It is profound, and it is something of a shift back to the state,” said Adam S. Posen, an economist at the Peterson Institute for International Economics. “But is this a recasting of capitalism? I think what we’ll see is that the government acts as a silent partner and gets out as soon as it can.”
Indeed, they say, many questions remain. Is the government picking winners in a plan that initially seems tilted toward the nation’s largest banks? What strings are attached to the investment in matters like executive pay? Will the move presage a more forceful government hand to control financial markets or will it be a brief stint as capitalism’s protector?
The package does call for the government investments to be in three-year securities that the banks can repay at any time, when markets settle and conditions improve. “This is clearly a crisis measure in crisis times, but it’s a good thing there is a sunset provision that limits the length of the government’s investment,” said Richard Sylla, an economist and financial historian at the Stern School of Business at New York University.
The United States is acting in step with Europe, where governments often take a more interventionist stance in economies and the financial systems are in the hands of a comparatively small number of banks.
Britain took the lead last week, declaring its intention to take equity stakes in banks to steady them. In the last two days, France, Italy and Spain have announced rescue packages for their banks that include state shareholdings.
The government’s plan is an exceptional step, but not an unprecedented one.
The United States has a culture that celebrates laissez-faire capitalism as the economic ideal, yet the practice strays at times. Over the last century, the federal government has occasionally taken stakes in railways, coal mines and steel mills, and has even taken a controlling interest in banks when it was deemed to be in the national interest.
The corporate wards of the state typically have been returned to private hands after short, sometimes fleeting, stretches under federal stewardship.
Finance experts say that having Washington take stakes in United States banks now — like government interventions in the past — would be a promising move to address an economic emergency. The plan by the Treasury Department, they say, could supply banks with sorely needed capital and help restore confidence in financial markets.
Elsewhere, government bank-investment programs are routinely called nationalization programs. But that is not likely in the United States, where nationalization is a word to avoid, given the aversion to anything that hints of socialism.
In past times of war and national emergency, Washington has not hesitated. In 1917, the government seized the railroads to make sure goods, armaments and troops moved smoothly in the interests of national defense during World War I. After the war ended, bondholders and stockholders were compensated and railways were returned to private ownership in 1920.
During World War II, Washington seized dozens of companies, including railroads, coal mines and, briefly, the Montgomery Ward department store chain. In 1952, President Harry S. Truman seized 88 steel mills across the country, asserting that unyielding owners were determined to provoke an industrywide strike that would cripple the Korean War effort. That nationalization did not last long, though, because the Supreme Court ruled the move an unconstitutional abuse of presidential power.
In banking, the government took an 80 percent stake in the Continental Illinois Bank and Trust in 1984. Continental Illinois failed in part because of bad oil-patch loans in Oklahoma and Texas. As the nation’s seventh-largest bank, Continental Illinois was deemed “too big to fail” by federal regulators, who feared wider turmoil in the financial markets. In the end, the government lost an estimated $1 billion on the bad loans it bought as part of the takeover of Continental, which eventually became part of Bank of America.
The nearest precedent for the Treasury plan, finance experts say, are the investments made by the Reconstruction Finance Corporation in the 1930s. The agency, established in 1932, not only made loans to distressed banks, but also bought stock in 6,000 banks, at a cost of $1.3 billion, said Mr. Sylla, the N.Y.U. economist. A similar effort these days, in proportion to today’s economy, would be about $200 billion.
When the economy stabilized eventually, the government sold the stock to private investors or the banks themselves — and about broke even, Mr. Sylla estimated. The 1930s program was a good one, experts say, but the government moved too slowly to deal with the financial crisis, which precipitated and lengthened the Great Depression. The lesson of history, it seems, is for Washington to move quickly in times of economic crisis with a forceful government intervention in the marketplace. And Ben S. Bernanke, chairman of the Federal Reserve, has studied the Great Depression and the policy miscues in those years.
“The goal is to get the engine of capitalism going as productively as possible,” said Nancy Koehn, a historian at the Harvard Business School. “Ideology is a luxury good in times of crisis.”
The traditional American reluctance for government ownership is not shared in other countries. After World War II, several European countries nationalized basic industries like coal, steel and even autos, which typically remained in government hands until the 1980s, when most Western economies began paring back the state’s role in the economy.
Europe remains far more comfortable with government having a strong hand in business. So when Sweden, for example, faced a financial crisis in the early 1990s, the nationalization of much of the banking industry was welcomed. The Swedish government quickly bought stakes in banks, and sold most of them off later — a model of swift, forceful intervention in a credit crisis, financial experts say.
“In Europe, the concept of the social contract is much more social — that is, socialist — than we’ve been comfortable with in America,” said Robert F. Bruner, a finance expert at the Darden School of Business at the University of Virginia.
“The obvious danger with anything that really starts to look like the government taking ownership or control of a significant piece of an industry is, Where do you stop?” Mr. Bruner said. “The auto industry is in dire straits and the airline industry is in trouble, for example.”
“But the spillover effects from the crisis in the financial system are so great, pulling down the rest of the economy in a way that no other industry can, so that the potential cost of not doing something like this is immense,” Mr. Bruner said.