From the September 20, 2009 Sunday Times (London)
September 20, 2009
by Irwin Stelzer
Even before last week’s reports of a rise in retail sales and industrial production, Federal Reserve Board chairman Ben Bernanke announced that the recession is “very likely over ... at this point ... we are in a recovery”. Not everyone agrees. Tim Drayson, an economist at Legal & General, fears that “the US and UK economies may suffer a relapse in growth”. Capital Economics thinks growth will “begin to fizzle out” by the middle of next year.
But the optimists are in the majority. Goldman Sachs says the recession ended in June, and Bank of America Merrill Lynch is expecting the economy to grow at a rate of 3% this quarter and 3.3% in the coming six quarters. (Remember:we economists use decimal places to prove we have a sense of humour.) Even the pessimists concede that the international financial system is back from the brink, that talk of another Great Depression was premature and, at least in the near future, growth will return, probably at a 3% annual rate. All of which has central bankers around the world mulling over exit strategies — ways to begin to withdraw cash and support from the economy. And President Barack Obama and his Treasury secretary, Tim Geithner, figuring out what policy modifications a nascent recovery requires.
The president’s strategy includes some exit, a dose of entry, and more than a little standing still. The exit applies to the propping up of the financial sector. Almost exactly one year after he agreed with others to let Lehman Brothers go down the tube — triggering a financial panic — Geithner says the government will allow its $2.5 trillion guarantee of the money-market mutual fund industry to expire on schedule at the end of the month. That programme headed off a threatened stampede of redemptions triggered by losses in a fund that had invested in Lehman debt. The Treasury secretary also supports the Federal Deposit Insurance Corporation’s decision to restrict its bank guarantee programme to only a few cases in the future.
The government is also chortling over the 17% return it says it has so far earned from bailed-out banks that got out of government support programmes by repurchasing the paper they turned over to the government in return for cash. Even woebegone Citigroup, which remains on government life support, is considering a partial exit. It wants to hold a stock sale that would reduce the government’s stake and allow Citi to raise much-needed new equity capital.
This gradual exit from support for the financial sector is being accompanied by an attempt to enter the boardrooms of many of the leading financial institutions. The Fed has announced that it will review the pay policies of some 5,000 firms and reject any that encourage excessive risk-taking. The president also wants reform — the Fed to regulate systemic risk; banks to carry more capital, which will certainly cut into profitability, dividends, and their ability to lend; capital requirements to reflect the risk exposure and size of each bank, with those deemed “too big to fail” required to have the greatest amount of capital; the government empowered to wind down any institution it decides is creating systemic risk; bonuses to be related to long-term performance and be recoverable if early profits are consumed by longer-term losses. In short, our president is in rough agreement with your prime minister as to what to propose at this week’s G20 meeting in Pittsburgh. Now it is up to Congress to decide just how much of what the president wants will actually become law. Lobbyists are out in force, regulators are in a battle over turf, and the end of the crisis reduces the urgency to act. But the deserved contempt in which many voters hold bankers these days suggests that more than a few new regulations will come out of the legislative machine.
There are a few areas where the administration is standing still, in part because it doesn’t know what to do. Housing is one of them. The $8,000 credit for first-time homebuyers is about to expire, and the housing and construction industries are pressing Congress to renew it, which it might do.
More important, the administration has not yet decided on the future of Freddie Mac and Fannie Mae, the two government agencies that are, in effect, the mortgage market. The government and the Fed have committed close to $2 trillion of investment and funds to purchase the agencies’ mortgage securities and debt. Repayment is unlikely. Meanwhile, the administration and Congress have to decide whether subsidising home ownership is good public policy, or whether they can rely on the market to attract the optimal amount of investment to housing.
Nor is the government clear on what it wants to do with General Motors and Chrysler. Obama says he didn’t run for president in order to manage car companies, and is considering selling off some GM shares early next year. But he has committed $83 billion to the car companies’ survival, and the new boards know that he expects to see more made-in-America fuel-efficient and electric vehicles rolling off assembly lines, and fewer Chelsea tractors.
Which brings us to Bernanke. He wants to see more life in the consumer sector, and probably a drop in unemployment before implementing an exit strategy. Most of the world’s central bankers agree with him that excess capacity in America and other big economies will keep inflation tame.
Others say that the central bankers are leaving too much cash sloshing around their nations’ economic systems, and that Obama’s unwillingness to rein in the federal deficit makes inflation almost unavoidable, which is why the dollar is sinking and gold soaring.
Both sides are hoping that Bernanke, who is having big problems with a Congress eager to end the Fed’s independence, puts his exit strategy into action neither so soon that he aborts the recovery, nor so late that inflation takes off. His ingenuity in coping with the recession suggests that if anyone can pull off this exquisite timing, Bernanke is the man.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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