FEIN: Chronic economic madness

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By Bruce Fein

COMMENTARY:

"What has been is what will be, and what has been done is what will be done, and there is nothing new under the sun."

The folly had seemed headed for final enactment in a Senate vote later this week until the House rejected it by a vote of 228-205 yesterday. If the bailout fails - which seems probable - another bailout will be promised as a new and better solution. Nothing has been learned from the futile bailouts of Bear Stearns, Fannie Mae and Freddie Mac and AIG.

More than 37 years ago on Aug. 15, 1971, President Richard M. Nixon succumbed to the political dynamics that chronically occasion futile government attempts to outfox the efficiencies of free-market economics. Greeted with popular cheering and media effusions, the Republican president announced his New Economic Policy: a 90-day freeze on wages and prices and a deflation of the dollar to make U.S. exports more attractive (and imports more expensive). Nixon clucked that, "We are all Keynesians now," an allusion to the idea nurtured by Democratic President Franklin D. Roosevelt that political epiphanies can defeat the laws of supply and demand.

I was then a callow law student and supporter of the Nixon administration. I naively believed that the Republican Party was dedicated to the principles of Adam Smith's "Wealth of Nations." Smith had sermonized nearly two centuries earlier: "The statesman who should attempt to direct private people in what manner they ought to employ their capitals, would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted to no council or senate whatever, and which would nowhere be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it."

The Scottish genius further taught that prosperity requires little else but "peace, easy taxes, and a tolerable administration of justice."

Economic wisdom, I quickly learned, is no match for political calculations. The days have long passed when King Canute eagerly demonstrated to his subjects the limits of his power by ordering the waves to turn back without result. No modern politician confesses to a corresponding incapacity to ordain a permanently growing economy by passing statutes or printing money. His popular stature and self-love would diminish.

Nixon's New Economic Policy was a homonym of Bolshevik Vladimir Lenin's New Economic Policy announced in the 1920s. Lenin's NEP, however, relaxed government controls on private enterprise in recognition that Soviet collectivization had caused massive famine and privations. Nixon's NEP featured the opposite, suggesting an acutely suboptimal economic learning curve. On the other hand, Nixon was no political slouch.

One of his fabled praetorian guards, H.R. Haldeman, reports in his diaries about Nixon's evening at Camp David before his Aug. 15 bombshell: "He was in one of his sort of mystic moods. [Nixon informed Haldeman] that this is where he made all of his big cogitations. ... He said what really matters here is the same thing as did with [Franklin D.] Roosevelt, we need to raise the spirit of the country; that will be the thrust of the rhetoric of the speech. ... We've got to change the spirit, and then the economy would take off like hell."

Roosevelt's New Deal interventions, however, had proven worse than the disease they purported to cure. The "Roosevelt Recession" of 1937 was followed by continued economic stagnation until Pearl Harbor and World War II propelled a take-off. In 1938, five years into Roosevelt's presidency, the unemployment rate stood at a staggering 19 percent.

Nixon clearly remembered that Roosevelt's political adeptness had overcome his economic follies. Roosevelt gained the presidency four times. He demolished Republican challenger Alf Landon in 1936 with the economy stuck in the doldrums. In the short run, economic misjudgments had been shown to carry little political risk if cloaked in fetching rhetoric like "malefactors of great wealth."

Nixon's NEP proved politically popular into 1972, enough time to enable the incumbent to crush Democratic rival George McGovern. But then came stagflation, i.e., inflation mixed with unemployment and soaring interest rates. Wage and price controls, but for oil and natural gas, terminated in 1974. But Nixon had wounded the economy sufficiently to defeat his successor, President Gerald R. Ford, and to impair the presidency of Jimmy Carter.

Government economic interventions are politically tempting because the immediate beneficiaries of jobs saved or businesses rescued are known. They will reciprocate with political support. On the other hand, the countless jobs not created or businesses not begun because the government has hogged capital markets to underwrite its interventions are nameless and faceless. They are political ciphers. And the taxes needed to fund government bailouts can be foisted on future generations by long-term borrowing.

The proposed $700 billion bailout pivots on a blatant falsehood: namely that unreasoning panic among investors has plunged the value of mortgages or mortgage-backed securities or other assets far below their "true" value as discerned by government gurus. The treasury secretary would buy the undervalued mortgages or securities and retain or sell them at a profit.

But price or value is determined by what a commercial instrument will fetch in an open market. There is no "panic" price that competes with a "nonpanic" price. The bailout legislation would thus empower the treasury secretary to choose which financial institutions to favor and to determine the amount of subsidy each favored institution receives in establishing the prices and volumes of mortgages or securities to be purchased.

Sound institutions that eschewed recklessly investments would receive nothing. The economically irresponsible will be preferred to the responsible. Politics will inescapably compromise an evenhanded administration of the bailout.

Remember the ill-conceived Reconstruction Finance Corp. born under President Herbert Hoover in 1932 to save banks, insurance companies, mortgage companies and public entities. Charles Dawes, the RFC's first head, joined a Chicago bank in July of that year. Within three weeks, his bank received a $90 million RFC loan. The treasury secretary will be a lobbyists' mecca.

Homeowners are guaranteed nothing from the bailout. Foreclosure relief is a rhetorical option at most. That may explain why the legislation is encountering strong headwinds. When the latest bailout predictably aggravates the economic downturn, more of the same will be the equally predictable iatrogenic remedy.

Bruce Fein is a constitutional lawyer with Bruce Fein & Associates Inc. and author of "Constitutional Peril: The Life and Death Struggle for our Constitution and Democracy" (Palgrave Macmillan).