Throughout more than a decade of recurrent crises in nations such as Mexico, Russia and Thailand, the United States offered the same advice: Let the market solve the problem and get the government out of the way. Even when the consequences of such economic "tough love" included widespread joblessness, soaring poverty and domestic turmoil, Washington insisted on the rule that the market knew best.
Now that it's the United States battling financial conflagration, it turns out there are exceptions to that rule. Such as Uncle Sam's takeover of AIG, the world's largest insurance company. Such as the quasi-nationalization of mortgage giants Fannie Mae fnm and Freddie Mac fre. Such as putting $29 billion of taxpayer money at risk to facilitate JPMorgan Chase's jpc acquisition of investment bank Bear Stearns.
"We're not doing what we preached," says economist Sung Won Sohn of California State University.
In their bold response to the deepening financial trauma, the Federal Reserve and U.S. Treasury Department appear to have tossed aside the playbook that guided official thinking on the economy for three decades. As a wounded financial system teeters on the edge of the abyss, the economic consequences of allowing major financial institutions to take their market lumps became apparent. "Disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth and materially weaker economic performance," the Federal Reserve warned in a statement announcing its extraordinary $85 billion aid for AIG.
At the White House on Thursday, a conservative president with a business pedigree and no affinity for overweening government made clear that authorities felt they had no choice. "These actions are necessary, and they're important. … Our financial markets continue to deal with serious challenges," President Bush said.
Former White House economist Nouriel Roubini, who forecast the current financial storm two years ago, has a harsher verdict. He says the USA is turning into "the United Socialist State Republic of America."
Sen. Jim Bunning, R-Ky., describing himself as "outraged" by the Fed's assertiveness, sounded a similar theme: "The only difference between what the Fed did and what Hugo Chávez is doing in Venezuela is Chávez doesn't put taxpayer dollars at risk when he takes over companies. He just takes them."
Today's made-in-the-USA crisis differs from the emerging markets crises that swept Mexico, Thailand, South Korea, Indonesia, Russia, Brazil and Argentina from 1994 to 2001. The origins of those countries' problems were found in capricious global capital flows and a mismatch between excessive borrowing in foreign currency and the countries' maintenance of fixed exchange rates. The current U.S.-centered cataclysm originated in the mortgage market with widespread provision of low-interest-rate loans to people who couldn't afford them and their subsequent sale as securities to institutional investors who barely understood them.
Past and present
But what yesterday and today have in common is a shared sense of financial engines that no longer are working. As the U.S. confronts its day of reckoning, the gap between the economic remedies it urged on others and its own actions are glaring.
In the 1990s, officials of the U.S. Treasury and the U.S.-backed International Monetary Fund urged the leaders of crisis-hit countries to embrace market-oriented policies designed to put their economies on sounder, long-term footing. But the recommendations — to slash government spending and privatize bloated state companies — meant genuine pain for millions and thus real political costs for leaders.
In 2001 in Argentina, millions of members of a thriving middle class were driven into poverty. In Indonesia in 1998, rioters burned shopping malls and storefronts in the capital city before driving longtime dictator Suharto into retirement. And in Russia that same year, the stock market lost three-quarters of its value and annual inflation topped 80%.
Officials in those countries at first resisted the harsh reforms, fearing exactly the sort of domestic instability that resulted. But they ultimately capitulated, realizing that their only hope of obtaining needed IMF financing was to comply with the global lender's conditions.
In demanding such painful changes, IMF and Treasury policymakers were guided by an economic philosophy known as the Washington Consensus. Emerging from the euphoria of the Berlin Wall's collapse and the embrace of the market by former socialist countries, the formula promulgated deregulation, privatization and open trade as the only path for countries seeking long-term prosperity.
Now, facing its own choice between the domestic pain associated with economic orthodoxy or postponing it by compromising long-cherished principles, pragmatic authorities have chosen the latter. Federal power has been stretched so far that the near unthinkable occurred this week: The Federal Reserve ran low on money, requiring the Treasury to stage a special $40 billion auction of government securities to replenish its coffers.
"The Fed and the Treasury have been more than willing to pour any amount of liquidity into the banking system and the financial system, to nationalize huge enterprises like Fannie and Freddie and to take any other measures. … It's clearly very much the opposite of what they prescribed to middle-income countries in the financial crisis in the 1990s," says Mark Weisbrot, an economist at the Center for Economic and Policy Research.
Weisbrot says it was easy for U.S. officials to push harsh policies upon developing countries, because they wouldn't be held accountable by hard-pressed voters. Now that they are in the political hot seat, he says, the choices look very different.
Washington's answer to the worst financial crisis in 70 years may run against the grain of the limited government philosophy. But Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke win plaudits from some for their creative response to a shape-shifting threat that seems to worsen by the day.
'This isn't France'
Kenneth Rogoff, former IMF chief economist, says officials deserve credit for refusing to bail out Lehman Bros., which filed for bankruptcy protection Monday, and for demanding stiff terms for government support of the other firms. The Federal Reserve is lending the insurer up to $85 billion at an interest rate 8.5 percentage points above the benchmark lending rate known as the three-month LIBOR. "They drove a very hard bargain," Rogoff says. "The government has no intention of running AIG for the next 20 years. This isn't France. This is temporary."
The distinction isn't so clear overseas. Sohn, the former CEO of Hanmi Bank, which serves the Korean-American community in the U.S., spent hours on the phone this week with Korean journalists puzzled by Washington's handling of Wall Street's meltdown. "They point out during the … crisis in 1998, Americans told them to sell off assets and get the government's hands off the private sector."
Indeed, the current environment is a far cry from the halcyon days of the late 1990s, when the dot-com boom left both Americans and their leaders ebullient. In June 1997, as world leaders gathered in Denver for the annual G7 summit, President Clinton hailed the dominance of the American model — to the barely concealed annoyance of his foreign guests: "Over the next two days, the eyes of the world will be on Denver and on America, and we'll all have a lot to be proud of. Our economy is the healthiest in a generation and the strongest in the world. … Now, America is poised to lead in the 21st century as we have in the 20th century."
Arguably, the last time Americans' livelihoods were this dependent on government was during the Depression.
No one expects a replay of mass joblessness at a level not seen before or since. But as policymakers scramble to craft a lasting answer to today's financial malignancy, echoes of Franklin D. Roosevelt's regulatory activism can be heard along the capital's marble corridors. The 1930s, with its cascading series of bank failures, marked the era when politicians and bureaucrats, desperate to alleviate suffering and prevent future financial disasters, erected an edifice their successors eventually would decry as "Big Government."
One of their signature achievements was legislation authored by Sen. Carter Glass of Virginia and Rep. Henry Steagall of Alabama. The measure prohibited investment banks, which bring securities to market, from owning commercial banks, which take deposits and lend money.
Investment banking is inherently risky, and a bank saddled with enormous losses on stocks and bonds may collapse. That's precisely what happened to thousands of banks in the 1930s.
By the time of the 1990s boom, the financial services industry was campaigning to repeal Glass-Steagall, arguing that foreign rivals were hobbled by no similar restraints. In 1999, Congress assented.
"The pressure was so great that Congress really couldn't resist it," says economist Peter Bernstein. "Nothing really bad had happened since 1982, and those bad things that did happen were transitory."
If important financial institutions failed, market participants and lawmakers alike felt that market forces could restore order on their own, with only minimal government aid.
Maybe they were wrong.
Contributing: John Waggoner