The Economic Catastrophe That We Avoided

-- Posted by Neil H. Buchanan

Last week, Professor Dorf posted some thoughts about the political activities of Virginia Thomas, who is married to Supreme Court Justice Clarence Thomas. Citing reports that Ms Thomas is the leader of a group of anti-government political activitists, Mike concluded that there is nothing unethical about what she is doing, even though her activities are "disturbing." Indeed. Put another way, the issue really boils down not to process but substance: It is the content of her revealed political views that should give us pause, not that she is doing these things as the spouse of a highly-placed government official.

The anti-government groups are (as far as anyone can tell) surprisingly small in number both compared to their recent influence on American politics, and also -- both as a cause and effect of that puzzling influence -- compared to the media's fascination with their activities. Even so, it is impossible at this point to pretend that their extreme views can be safely ignored. I share Mike's conclusion that these views are "disturbing," and this seems like a good opportunity to discuss a few reasons why the views of these anti-government activists are scary.

Because of their small numbers and relative lack of organization, we must be somewhat tentative in ascribing a set of beliefs to a group that seems more motivated by unfocused rage than anything else. Still, it seems plausible to isolate a core set of common beliefs. One major player in the movement is former House Majority Leader Dick Armey, who has reportedly been pushing hard to put the entire focus of this movement on economic issues rather than social issues like abortion, gay marriage, etc. The idea, apparently, is that everyone can agree on balance budgets, even if they cannot agree on what is a sin.

Because macroeconomic policy is my principal area of scholarly commitment, and budget deficits are my focus within macroeconomic policy, I am particularly concerned with the economic arguments that we are hearing from the anti-government crowd. Bob Hockett's post here on DoL last Friday did a very nice job of discussing the most important long-term damage caused by anti-deficit mania: short-changing public investment in a completely distorted effort to achieve "fiscal responsibility." I even saw one protester recently carrying a sign that read: "Spending ≠ Investment." Yes and no. Some spending is not investment, but other spending is. Pretending that all spending is the same is simply foolish. Bob's post is extremely clear and persuasive on this issue.

Here, I will focus on the other big economic issues that seem to unite this crowd: they oppose short-run deficits -- even in the face of a near-depression -- and they oppose all bailouts. Consider what the world would be like if politicians had followed this advice.

Eighteen months ago, we were watching the financial system implode, with some of the largest and most influential financial institutions in the country disappearing or, at least, becoming technically insolvent. The entire financial system was experiencing a "run" of historic proportions. The Bush administration proposed a 3-page bill giving Treasury the right to extend $700 billion in bailout money to those institutions. Understanding that -- when it comes to legislative language -- short is not sweet, the Democrats in Congress passed a different, longer bill with important oversight mechanisms and at least a decent chance of working. The Obama administration came into office and continued to administer that program. Meanwhile, the Fed pumped hundreds of billions of dollars into the banking system, to prevent the run on the financial system from bringing down the entire economy.

Twelve months ago, it looked quite possible that the symbol of American capitalism, GM, would cease to exist. Chrysler was on the rocks, too. In the midst of an economy that was already hemorrhaging jobs, this raised the specter of another million jobs being lost (in the auto industry and in auto-dependent companies) -- with those losses being concentrated in areas such as Michigan and California, which were already in huge trouble.

Some people said that we should just let GM and Chrysler fail, and Americans could buy cars from well-run companies like Toyota. (Ahem.) Instead, the Obama administration and Congress bailed out both companies, letting them move through modified bankruptcy proceedings to emerge as viable enterprises.

At the same time, Democrats in Congress (with no votes from across the aisle) passed a medium-sized fiscal stimulus package.

Where are we today? The financial system looks to be emerging from its deep freeze. Financial institutions have been tripping over themselves to pay back their bailout funds, in part to get out from under government oversight rules that they did not like. (Incentives can work.) The taxpayers have spent substantially less than the initial price tag suggested, and the ultimate number could approach zero. Meanwhile, the Fed has begun to work out plans to drain the liquidity that it pumped into the system. The auto companies have not been in the news lately, which counts as unmitigated good news.

It is, of course, possible that this is entirely a post hoc fallacy. Just because a Democratic Congress, the Bush and Obama administrations, and the Fed worked together on policies to save the financial system does not mean that the financial system's non-collapse and the economy's tentative recovery were caused by those policies. Maybe things would be even better if no one had done anything. Other than simply believing that the economy would have fixed itself (because that is what the economy unerringly does), however, there is no reason to believe such claims.

Moreover, it is difficult to take such an argument seriously from people who argue, for example, that Ronald Reagan "ended inflation" and "defeated the Soviet Union." If it happened on his watch, he caused it. Now, as we come back from the brink of financial collapse, as we see a stabilizing jobs situation (as a prelude to turning it around, one hopes), and as we see clear signs of economic health throughout the economy, can we not conclude that this was similarly "caused" by policies that Congress, the President, and the Fed enacted?

Beyond the issue of hypocrisy, the more important point is that there actually is a logical sequence by which we can understand the success of these policies. Banks were threatened with collapse because their liquidity had evaporated; TARP and the Fed provided liquidity; and the banks did not fail. States and cities were going to lay off teachers and cops; the stimulus gave them money to make that unnecessary; and the states and cities fired fewer teachers and cops. This is not difficult to follow.

The idea that these successes were accomplished at an unacceptably high cost -- by piling "mountains of debt" on future generations -- is simply wrong. Borrowing money to keep American capitalism -- financial capitalism and industrial capitalism -- alive is hardly a burden on the future. The whole point of short-term policies is to prevent the flu from becoming pneumonia. At this point, it looks very much like that is what we have done. The costs will be easily borne in the future by a larger, healthier economy than we otherwise would have bequeathed to our progeny.

As it happens, I have been critical of President Obama on both the stimulus and bailouts. My concerns, however, have been quite different: (1) There has been too little deficit spending, given the enormity of our economic problems (especially the punishingly high levels of unemployment), and (2) The bailouts were extended on terms that were both too generous and (therefore) politically damaging. The anti-government protesters, however, would have none of either.

We can argue forever about counter-factuals, but the reality is that we seem to have successfully avoided an economic catastrophe of epic proportions -- the kind of catastrophe that would have brought down the largest economy on earth (and the world's other economies with it). I am not happy with much of what happens in Washington, but the politicians did something very right. They could have, and should have, done even better; but at least they did not abandon their responsibilities to the nation and to future generations by listening to those who shouted at them to do nothing.