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Trump's Fiscal Policy Is Moving from Loose to Reckless

Irwin M. Stelzer

“Oh, when will they ever learn?” asked Pete Seeger in 1955. Surely not by 2008, when Lehman Brothers, the fourth largest bank in America, was forced to file for bankruptcy after 158 years in business because Wall Street titans had failed to learn the lesson of crises past: that they must all hang together or most assuredly they would all hang separately, to borrow from that 18th century font of wisdom, Benjamin Franklin.

One hundred years before Lehman discovered that mortgage-backed securities were not a sure basis for continuing profits, J.P. Morgan ended the 1907 financial panic by locking a group of bankers in his library until each one agreed to contribute to the bailout of the failing Knickerbocker Bank, and thereby avoid a market collapse.

And ten years before Lehman Brothers collapsed, Long Term Capital Management, a hedge fund that at its height controlled over $100 billion, was bailed out by a group of Wall Street investment bankers at the urging (insistence?) of Alan Greenspan. The then-chairman of the Federal Reserve System feared an LTCM collapse would trigger a financial meltdown. The irony is that the highly-leveraged hedge fund’s board included Robert Merton and Myron Scholes, two economists who had won the Nobel Prize for their development of a new method of valuing derivatives, which Warren Buffett later described as “Weapons of mass destruction . . . potential time bombs.”

Treasury secretary Henry Paulson lacked the persuasive, or coercive, powers of Morgan and Greenspan. Worse still, because both presidential candidates at the time—Barack Obama and John McCain—had pledged no more taxpayer bailouts, Paulson could not offer to help by throwing some government (translation: taxpayer) money into the pot. It is likely that both candidates drew on polls rather than on their close familiarity with the experiences of J.P. Morgan and LTCM when formulating their respective policies.

So down went Lehman, leaving its 25,000 employees to clear their desks and polish their resumes. The rest is, as they say, history. The 17-month bear market that had begun almost a year earlier lopped about 50 percent off the value of both the S&P 500 and the Dow. The accompanying Great Recession saw the unemployment rate double from 5 percent to a peak of 10 percent before the labor market began to recover. The housing bubble burst. The effects rippled through the international financial system.

That was then, this is now. The S&P 500 now stands at more than twice the level to which it fell on the Ides of September 2008. The economy grew at an annual rate of 4.2 percent in the last quarter. The economy created 201,000 jobs in August; the unemployment rate is 3.9 percent; average hourly earnings increased by 2.9 percent, the fastest rate since June of 2009; and the labor force participation rate continues to tick up. As Eric Rosengren, president of the Federal Reserve Bank of Boston put it, the economy is “exactly where we want it to be right now.”

***

So no more Lehmans?

Christine Lagarde, managing director of the International Monetary Fund, doesn’t think so. Asked what worries her these days, she replied “everything.” She believes that Lehman Brothers might still be with us if it had placed more women—less reckless, more prudent than men—in top jobs: “If it had been Lehman Sisters, . . . the world might look a lot different today.”

There is no question that the financial system is in better shape than it was ten years ago. Banks are better capitalized, supervision is better focused, stress tests must be survived, liquidity requirements are higher.

But neither is there any question that there are two clouds on the horizon. One is the president’s use of tariffs to produce a world trading order fairer to the United States. That seems to have our trading partners figuring out just what concessions will satisfy him. But there is a danger that tariffs designed to bring our partners to the table will remain a permanent part of U.S. economic policy—witness the fact that an agreed deal with Mexico does not include a repeal of tariffs on its steel and aluminum.

And Trump’s fiscal policy is moving from loose to reckless: plans for tax cut 2.0 are solidifying, even though the first round of cuts is likely to produce unsustainable deficits. Little thought is being given to the consequences other than the effect on the November elections. Former New York senator Daniel Patrick Moynihan, who knew a thing or two about how politicians think, had it right when he said, in a different context, “the powers of the mind include that of minimal understanding of what is inescapably ahead.”

The second cloud is excessive debt. Governments have yet to learn the dangers of excessive debt, taken on when interest rates are low. Venezuela and Argentina are extreme examples. Italy has succeeded Greece as Europe’s main concern. And our government is borrowing money to fund tax cuts, which give consumers money to spend so that they have less need to borrow personally as they ramp up their spending.

So far, consumers seem able to carry the debt they have taken on. Credit card delinquencies remain low at 2.4 percent. But savings rates are also low: 40 percent of adults say they would not be able to pay all their bills if faced with a $400 emergency, and auto loan delinquencies continue to mount, unusual in an economy as healthy as ours.

In 2008 Queen Elizabeth asked some economists, “Why did nobody notice” the oncoming Great Recession? The public response of a group of eminent economists, “It . . . was principally due to a failure of the collective imagination of many bright people . . . to understand the risks to the system as a whole.

Perhaps we have learned enough in the past ten years to “notice,” and prove to Seeger that since Lehman we have indeed learned at least something about how the economy works.

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