Judging the success of the actions undertaken by the Federal Reserve and United States Treasury will be exceedingly difficult for the reason that Ludwig von Mises pointed out some 80 years ago — there is no profit mechanism for government bureaucracies such as guides firms in a market economy.
The success of Bank of America’s strategies will be easily seen. If two years from now the company is earning substantial profits and the stock is up, then we can pretty well judge that the strategies it undertook were successful. If Bank of America has gone the way of Pan American Airlines, then we can be sure its strategies were not successful. Such will not be true of the actions of the federal government.
We can judge to a certain extent the failure of the actions of the Federal Reserve and Treasury to accomplish the goals that they have set for themselves. The primary goal has been stabilizing the credit markets.
There is currently a tightening of the credit markets despite liquidity being provided by the Federal Reserve. Banks are reluctant to lend to one another, to businesses, and to consumers. This is because of the reduction in capital they have suffered and uncertainties regarding borrowers’ ability to make payments.
While it is the subject of another essay the extent to which the government has been culpable in the creation of this situation, we at least know the goal of the “plan” is to unfreeze the credit markets. The failure of this will be relatively easy to judge as there are indicators of failure — interest rate spreads, inability of business to borrow, and a collapse of the commercial paper market would all indicate the government’s plan has failed.
A second goal, implicit if not explicit, of the federal government, is to prevent a major fall in the equities market. Again, there are indicators that will show whether this goal has been accomplished. Certainly the reduction in the Dow Industrial Average of well over 1500 points as of this writing since the passage of the bailout plan by Congress indicates that the plan has either failed in this respect or it has not yet succeeded. Speed may be of the essence in judging the failure of the government in this regard, since if the Dow recovers 10 years from now, then few would judge the plan a success.
The third major goal of the government plan is to avoid a recession, or at least a deep recession. The National Bureau of Economic Research (NBER) provides a ruling on whether a recession has occurred or not, so we will eventually have a judgment on the failure of the plan. However, as has been explained in these pages before, the NBER may take some time to officially declare a recession.
There are other quick and dirty indicators, such as declining GDP and rising unemployment that will give us a more timely measure of the government’s failure or success. If a mild recession occurs, such as two quarters of decline of real GDP of one percent or so, and a rise in unemployment to eight percent, it will probably be fair to declare that the government did not fail. Certainly four or five quarters of real GDP declines and a rise in unemployment to 10 percent would have to result in calling the government’s plan a failure.
While we can determine when the plan has failed to achieve its goals, we won’t be able to tell if the plan has achieved its goals. This is because markets will tend to equilibrium. While market disequilibrium is certainly occurring all the time in a dynamic economy, markets generally move towards equilibrium.
The markets will eventually provide enough opportunity for profit that entrepreneurs will figure out on their own how to solve the credit liquidity crisis. Indeed, it is possible that the government actions are creating uncertainties in the market that are increasing the length and breadth of the credit crisis.
Certainly the equities markets will reach equilibrium at some point and begin to move upwards. In the long run, stock market values reflect the underlying values of the companies. At this point there are stocks out there that do not reflect the long term value of the companies and some managers or individual investors will purchase these and eventually there will be a floor to the market.
The same is true for the real economy. Once the malinvestments (to use Hayek’s term) in the housing markets have been worked out, the economy will resume its expansion. Markets are fundamentally sound and are the most efficient way of allocating resources. In the absence of government intervention we will not see 25 percent unemployment rates, as wages and prices will adjust to move us to full employment.
Thus, it is almost a certainty that the credit markets will unfreeze, the stock market will recover, and the economy will resume its long run growth trajectory.
The government will at some point claim the credit for this and the media will report it as such. However, this is much like the story of the guy on the park bench waiving his newspaper to scare away the elephants. When told that there are no elephants around, the guy answers, “See…It works.”
The only part of the government’s plan we can judge as a success is if it de-socializes the financial system that it is currently socializing. If all government positions in Fannie Mae and Freddie Mac, as well as AIG and every other institution the Treasury ends up owning, are sold back to the private sector, then there will have been a partial success. There will still remain that the precedent was set as well as the creation of moral hazard, but this may be the best we can hope for.