Laurence J. Kotlikoff and Perry Mehrling have a fascinating opinion piece in today’s Washington Post arguing that we are actually all going to be fine and that the coming recession is going to be quite modest—at least in the US. Here’s the nub of their argument:
“Uncle Sam (a.k.a. Treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke) is doing precisely what’s needed to avoid the mistakes of the 1930s. With credit markets drying up, he’s turning on the faucet by recycling our panic dollars back into the financial market.
The government is taking in our money (in exchange for Treasury bills) and using it to make mortgages and buy up the assets we’re too scared to hold. It’s doing this via the Treasury, the Fed, the Federal Deposit Insurance Corp., the Federal Housing Administration, the Federal Home Loan Bank, Fannie Mae, Freddie Mac and other appendages. It’s starting to lend directly to large and small businesses whose usual sources of credit have become unavailable.
In short, Uncle Sam is becoming our new bank. He has also become our new insurance company with his effective purchase of the world’s largest insurer — AIG.
In the 1930s, nobody in the private sector could borrow, raise equity or sell insurance because everyone lost trust in everyone else. Uncle Sam stood on the sidelines and marveled at the chaos. But today Uncle Sam is saying, “Listen, if you households and firms are too scared to invest in each other or sell each other insurance, give us your money, and we’ll do it for you. We’ll pay you a sure return on the Treasuries and, if our investments and insurance sales do well, you’ll benefit by paying lower taxes.”
This may sound like socialism or state capitalism, but it’s simply rearranging the financial furniture. As Americans have freaked out, Uncle Sam has stepped up. He’ll continue doing so until we realize the sky is not falling. The $700 billion rescue authorizes the federal government to keep doing what it has been doing for the past year to the tune of $400 billion — buying distressed assets at bargain-basement prices and selling insurance at high premiums. If all works out, Uncle Sam will make a killing. This would be great, given our government’s real problem — paying the long-term Social Security and medical costs of retiring baby boomers.”
Now, this all strikes me as slightly too rosy. But it does suggest that the next depression talk that is becoming so common is decidedly over-egging the pudding.
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