3-18-08 Deregulation and Crises

The Federal Reserve is being hailed for saving the financial system through backroom, big-dollar deal patched together in the small hours of a Sunday morning. If the financial and economic systems are going to collapse without this single and particular action, shouldn't we be asking questions about the vulnerability of the underlying real economy?

This immediate crisis was brought on by the deliberate failure to regulate mortgage and derivative markets. The deeper problem is not the financial economy of Wall Street gamblers, which can be fixed with prudent house rules, but the real economy of people and production which the finances are supposed to reflect and support.

The problem arose last week when the 85-year-old Wall Street firm Bear Stearns collapsed in just four days. Over the weekend, J.P. Morgan bought the firm for a token $2 a share in a deal brokered and guaranteed by the Federal Reserve and the US Treasury. Last year, this fifth largest of the investment houses had boasted a value of $170 per share.

The Fed took this action because it considers Bear Stearns "too big to fail." The Fed thinks that Bear Stearns is so big and so integral to the system that its failure would destroy the stability and liquidity of the American and world financial systems. The Fed is probably right but isn't something really wrong when a government allows the world economy to become that vulnerable to a single event.

The Fed officials are talking about minor tinkering with the financial regulations. But they are not planning any substantial action to remove the underlying structural instability from the American economy. In the face of a collapsing economy, they are sticking to financial nostrums like lowering the interest rate, auctioning bonds and a stimulus package.

The American economy is facing a far bigger problem than the possible collapse of Bear Stearns. Every one knew that the Bear Stearns officers were swashbuckling gamblers and that the whole financial sector was and still is leveraged beyond good sense.

At the same time everyone also knows that wages have been stagnant for 30 years and that this has given us an income distribution so skewed that workers can no longer afford to educate their children or save for their retirement.

The average middle-class American has no liquidity at all; he is in debt and in trouble. Our real problem is the paying his mortgage and not the financial shenanigans of greedy Wall Streeters. The middle-class problems were in fact the real trigger of the coming train wreck of an economic crisis. Bear Stearns is a symptom, not a cause.

The Fed is, of course, treating the symptoms. The Fed stands ready to accept billions of dollars of worthless paper as collateral on cash loans to another 20 private investment companies. The final payout to wealthy Wall Street investors could well be many times the ineffective and short-term $180 billion of stimulus package that will be divided between the rest of us beginning in May.

Despite what the president said this weekend, it is not true that "the economic foundation is solid." This government has waited too long to begin to do its job: the dollar is not just falling but losing its place as the world's currency, the emerging Chinese economy is sinking deep roots not just here but in Africa and Latin America, our trade and budget deficits reflect profound structural weaknesses at and we are already in a recession of unpredictable length and depth.

The middle-class is taking a hit in food, energy, and housing -- and what else really counts, except healthcare, which is in a class by itself. For those who do not do the shopping or pay the heat bill, over the past year the price of fruits and vegetables rose 20%, pasta products 40% and egg prices jumped 60%. As for energy, oil is over $100 per barrel, the price of gasoline is reaching for four dollars a gallon at the pump

The history of our money following the deregulation of the 1980s is like a roller coaster of the ups and downs of greed and the increasing vulnerability of our system: the S&L scandal of the late 80s the BCCI banking scandal and the Barings bank collapse of 1991, Enron in 2001, the Tyco, WorldCom, Global Crossing and HealthSouth of 2002, Enron in 2003 and now this.

Remedies were available over the years to maintain wage levels and jobs, to rebuild the infrastructure and our competitiveness and to strengthen our financial system. But no one did their job. They deferred to their free-market ideology until, now, the economy itself needs serious bailing out.

Too little government and not too much brought us to the vulnerability of a Bear Stearns. Government is the only solution to a common problem like managing a financial system.