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August 2010
Striking the Right Balance
By John Paul Galles

     I just finished reading Hank Paulson’s book, On the Brink. As Secretary of the Treasury under President George W. Bush, Paulson and Ben Bernanke, Federal Reserve Chairman, managed the federal government response to the recent banking crisis. Paulson’s recall about his day-by-day experiences was fascinating. Living in Charlotte with Bank of America, Wachovia and Wells Fargo, we watched anxiously as the crisis unfolded.  Knowing people from both institutions, we anguished with them as they neared collapse in front of our eyes.

     Paulson’s perspective on the crisis was illuminating. The interactive relationship between the banks and investment firms and the mortgage industry and derivatives created a house of cards that were shaken by overleveraged assets in a globally connected marketplace.

     The total collapse of our international financial system was substantially averted in the United States by the actions of Paulson and Bernanke. The dominoes started falling with HSBC mortgage defaults in February of 2007, followed by the demise of Bear Stearns in June 2007, and huge losses by UBS, Citigroup, Merrill Lynch, JP Morgan Chase, Goldman Sachs and Countrywide into the first half of 2008.

     Fannie Mae and Freddie Mac were nationalized in early September 2008; Washington Mutual failed and was sold to JP Morgan; Lehman Brothers failed; Bank of America bought Merrill Lynch; and Wachovia experienced a run on deposits and was to be sold to Citigroup but was eventually acquired by Wells Fargo. In early October, Congress passed the $700 billion bailout bill and Barack Obama was elected President in November 2008.

     Looking back at his experience, Paulson writes,

     “The history of capitalism in America has been one of striking the right balance between profit-driven forces and the array of regulations and laws necessary to harness these forces for the common good. In recent years, regulation failed to keep pace with rapid innovations in the markets—from the proliferation of increasingly complex and opaque products to the accelerating globalization of finance—with disastrous consequences.”

     Just last month, Congress passed and President Obama signed into law the Financial Regulatory Reform bill to help avoid such disastrous consequences in the future. It is an attempt to strike the right balance between free market forces and regulations for the common good. Putting the rules in place for bank practices provides a platform on which banks can do business going forward. It establishes a framework within which they can conduct business and make investments. It was a necessary and important step.

     But our jobless economic recovery will never be a real recovery unless or until our jobless rate returns to a more normal level of 5 to 6 percent. Behind the official unemployment rate of 9.5 percent in June 2010 are many more who are under-employed. We cannot have a real recovery without the flow of investment, so the reform should be an impetus.

     Next on the agenda for Congress and the American public will be federal taxes and spending. Nearly 85 different tax cuts implemented over the last 10 years are set to expire at the end of 2010. If the cuts are allowed to simply expire, all the tax rates will return to previous levels.

     The battle that is about to ensue over these tax rates as well as government spending including entitlements will be extraordinary. If you thought Congress was already dysfunctional, you haven’t seen anything yet. Our federal deficit is unsustainable without seriously damaging our economy and our future.

     We will see if we can strike the right balance between the free market forces and regulations for the common good with new taxes and new spending cuts that lay the groundwork for our collective economic future.

     We cannot balance our budget simply by raising taxes or by cutting spending. It will be arduous and exhaustive effort negotiated in our political arena. As was quite obvious from Paulson’s experience, the battle ahead will be an arduous, gut-wrenching, heartfelt, nasty, underhanded-at-times, overwhelming experience and likely to prove even more enormous, complex and important than the struggle to save our financial system.

 

John Paul Galles is the publisher of Greater Charlotte Biz.
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