Forget Adam Smith, Whatever Works.
Washington's partial nationalization of banks marks a fundamental shift in thinking about the relationship of the public and private sectors.
A week of astonishing developments in the global stock and credit markets, Federal Reserve Bank of Dallas President Richard W. Fisher addressed the high and mighty of global finance in Washington during pivotal meetings of the Group of Seven and the International Monetary Fund. The gravity and complexity of the 15-month-old credit crisis called for action that transcended familiar ideological categories, he hinted, such as free markets vs. state intervention. Fisher even borrowed a Chinese proverb popularized by the late Chinese leader Deng Xiaoping: "No matter if it is a white cat or a black cat, as long as it can catch mice, it is a good cat."
Back in the late 1980s, Deng meant that China needed to abandon basic tenets of socialist orthodoxy that stood in the way of prosperity. In these tough times, the proverb resonates in another way. The Bush Administration, by committing $250 billion to buy equity stakes in a huge swath of the U.S. banking system and extending all manner of financial guarantees to depositors and money-market investors, has just violated some enshrined principles of American-style, free-market capitalism.
You might dismiss all this as extreme measures for extreme times, a pragmatic adjustment that will be quickly undone once order is restored. But the significance, not to mention irony, of a Republican Administration partially nationalizing the U.S. banking system cannot be overstated. It could well go down as an important turning point in postwar American economic history, the beginning of a fundamental rethink of the proper boundaries between the public and private sectors. "The pendulum between the state and markets is swinging back before our eyes," says Daniel Yergin, co-author of the 1998 book The Commanding Heights, which chronicled the triumph of market capitalism over state-led economics since World War II. "And it is happening a lot faster than anyone expected."
As America struggles to recover from the deep recession that likely lies ahead, a new economic model could take shape that would involve a great deal more than direct government involvement in the world of Wall Street. It could mean greater support of such industries as autos, nanotech, and renewable energies, which face fierce global competition. And it certainly spells a return of heavier regulation. It is far too early to predict that the U.S. is headed down the road of Asia-style industrial policy or the kinds of interventions imposed during the Great Depression, when bureaucrats seized and micromanaged entire industries. The U.S. won't have voting rights on the preferred shares it bought in Bank of America, Citigroup (C), JPMorgan Chase (JPM), and others. And analysts doubt Washington will dictate lending. But as Yergin notes: "The political process has not even begun to get ahold of this." If Barack Obama wins the Presidency, possibly with a filibuster-proof majority in the Senate, the next Administration could have a mandate for sweeping change.
Unlike many other recessions, this one wasn't caused by a downturn in a few specific industries. It started with a housing bust and then metastasized into a full-blown credit crisis that eventually destabilized the entire U.S. financial system. As previous financial crashes in nations such as Japan and Mexico have shown, recovery can take years. "We will see de-leveraging on such a scale that we are in uncharted waters," says economist Hung Tran of the Institute of International Finance, a Washington think tank.
In fact, the crisis has been so devastating that once-cherished assumptions about the superiority of the U.S. economic model are now in doubt. Take the notion that the American economy could keep flying high as its manufacturing base withered. The idea presumed that innovation and productivity alone would create the wealth and high-paying jobs needed to boost U.S. living standards.
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