President Obama is now apparently concerned enough about the doubts about his government interventions in the economy that he sent one of his top economic aides, Lawrence Summers, off to New York to try to reassure America. Mr. Summers, in his talk at the Council on Foreign Relations, acknowledged that "suggest that the interventions of the last year represent an overreach, a kind of back-door socialism that may threaten the very underpinnings of our market-based economic system." Much of his talk was aimed at answering that accusation:
any interventions in which we participate will go with, rather than against, the grain of the market system. Our objective is not to supplant or replace markets. Rather, it is to protect the market system from its own excesses and to improve the protection of that system going forward.
You know, in the long sweep of history, Franklin Roosevelt's policies were denounced by many at the time as a radical attack on capitalism, but today are understood to have helped preserve the market system.
So, too, our approaches are directed at protecting and strengthening, rather than replacing, the market system….Only if government is no longer a major presence in these companies in short order will we have fully succeeded in achieving our critical objectives.
Mr. Summers is not only an economist, he is also smart, and his remarks are worth reading carefully as a thorough statement that attempts a defense of the administration's actions. While they may reassure some, they won't reassure everyone. For all the talk about the administration's "objective" or the goals to which its policies are "directed," plenty of government programs start off with a worthy objective but, because of the law of unintended consequences, wind up accomplishing other objectives quite different from the original ones.
To take just one example, Mr. Summers observed, "In the last generation, we've seen in the financial sector a Latin American debt crisis, the 1987 stock market crash, the commercial real estate collapse and the S&L debacle, the Mexican financial crisis, the Asian financial crisis, the LTCM liquidity crisis, the bursting of the NASDAQ bubble and Enron -- all of that before the events of the last two years. That works out to something a bit over one major crisis every three years." He focused on "the need for a systemic risk regulator " to provide "greater stability and safety," presumably eliminating some of the crises. But those crises every three years had the beneficial effect of reminding investors of risk. If the stock market and real estate prices never collapsed or crashed but just steadily rose, so much money might pour into those asset classes that prices would soar to a point where they would be disconnected to underlying values. Then if the "systemic risk regulator" made a mistake, the effect might be cataclysmic. The actions or even the mere presence of a systemic risk regulator, in other words, might lull investors into a false and ultimately dangerous sense of security.
Three analogies may be useful. The first is bicycle helmets. In a classic New York Times article, my friend Julian Barnes observed that as bicycle helmets became more widely used, serious head injuries by cyclists increased. The article suggested that "the increased use of bike helmets may have had an unintended consequence: riders may feel an inflated sense of security and take more risks." A systemic risk regulator could have the same adverse effects on investors.
The second analogy is firefighters and Western forests. Before firefighters, lighting strikes ignited frequent fires that helped assure the health of Western forests. With the advent of firefighters, deadwood built up on the ground, and when a fire finally escaped the firefighters and burned out of control, it was hotter, deadlier, and more devastating than ever. If a systemic risk regulator succeeded in eliminating some of those every-three-year crises the way a firefighter eliminated the regular lighting-caused fires, the crises that did emerge might be unusually severe.
The third analogy is missile defense. Many of those on the left arguing for a systemic risk regulator for the economy opposed national missile defense for America on the grounds that it was technically infeasible and that it would create a false sense of security that would engender unsafe risk-taking. Many on the right who supported national missile defense oppose a systemic risk regulator using arguments that the left used against missile defense. Whatever your politics or your views on missile defense, the analogy may help clarify some of the issues and arguments.
At least one of the claims Mr. Summers used to advance his argument for a systemic risk regulator struck me as suspect. "The center of this crisis has much more to do with excessive leverage, has much more to do with unregulated institutions that have no regulation for systemic risk, like the AIGs," Mr. Summers said. AIG may have been a lot of things, including badly regulated, but "unregulated" it wasn't. As this NPR story reports, AIG was regulated by the Office of Thrift Supervision. It was regulated by the New York State attorney general so vigorously that in 2005 the state attorney general forced out the chief executive who had built the company, Maurice "Hank" Greenberg. It was regulated by the Securities and Exchange Commission, the Department of Justice, the New York State insurance department, and the New York State attorney general so vigorously that in 2006 AIG agreed to a $1.6 billion settlement with those regulators. The idea that the financial crisis arose because AIG was "unregulated" just doesn't seem supported by the facts.