consumer deposits and generate home loans—think Jimmy Stewart in
Once again, the unimaginable happened. Commercial real estate prices dropped, and many of the loans made by the S and Ls went into default. The size of the problem was vast and cut two ways. First, individual depositor money was at risk on a large scale. Second, the failure of an entire segment of the financial industry, which had resold its commercial mortgages into the broader market, was poised for catastrophe.
The federal government intervened by taking control of failed S and Ls—meaning most S and Ls—and assuming their liabilities. Mortgages in default were foreclosed, and the underlying property was taken over by a newly created institution called the Resolution Trust Corporation. Rather than try to sell all this real estate at once, thereby destroying the market for the next decade, the RTC, backed by federal guarantees that potentially could have risen to about $650 billion, took control of the real estate of failed savings-and-loans.
The crisis of 2008 was based on the same desire for low risk, and on the same assumption that a certain class of assets was indeed low-risk because its price couldn’t fall. It was met with a similar federal government intervention to bail out the system, and, just as before, everyone thought it was the end of capitalism. What is important to note is the consistent pattern, including the overstatement of the consequences. To some extent, this is a psychological phenomenon. With pain comes panic, and the management of panic is a question of leadership. Consider how it was managed in the past.
Both Franklin Roosevelt and Ronald Reagan came to power amid economic crises. Roosevelt, of course, faced the Great Depression. Reagan faced the stagflation that overtook the economy in the 1970s—high unemployment combined with high inflation and high interest rates. The economic problems both presidents encountered were part of global economic dislocations, and both posed a profound crisis of confidence in the United States. The crisis in the 1930s prompted Roosevelt’s famous line, “We have nothing to fear but fear itself.”
Roosevelt and Reagan both understood the psychological element in financial crises. The anticipation of economic hardship causes people to rein in their buying in order to protect themselves. The more they cut back, the worse the economic problems become. As an economic crisis deepens, it calls into question the integrity and leadership of elites, which can create political instability and destabilize society itself. That social uncertainty can in turn make it impossible for a country to act decisively in the world. Roosevelt faced the rise of fascism; Reagan came to power facing what was generally believed to be the growing power of the Soviet Union. Neither could afford the destabilizing consequences of a severe economic crisis, yet neither knew with any certainty how to solve the problem through economic policy. Both attacked the psychology of the problem, trying to create the sense that, most of all, something was being done.
In retrospect, Roosevelt’s frantic one hundred days of legislation had little effect on the Depression, which was ended by World War II rather than by his economic policies. Reagan also promised actions, although in the end the solution rested not with the president but with the Federal Reserve. Nonetheless, describing the times as being “Morning in America,” a phrase that was part of his 1984 campaign, Reagan, like Roosevelt before him, tried to change the expectations of the public, stabilizing the political situation and buying time for the economy to heal without weakening the state.
Both Roosevelt and Reagan understood that the real threat of an economic crisis would be its political impact, with the misery that piled up wrecking the entire system. They understood that their job as leader was not to solve the problem—the president really has little control over the economy—but to convince the public not only that he has a plan but that he is altogether confident of that plan’s success, and that only a cynic or someone indifferent to the public’s well-being would dare to question him on the details. This is not an easy thing to pull off; it takes a master politician, which is to say a master of illusion. Roosevelt certainly saved the country from serious instability and, in spite of the lack of recovery, positioned it to fight World War II. Reagan saved the country from the sense of malaise that the Carter administration was known for and set the stage for the reversal of fortunes with the Soviets.
Roosevelt and Reagan did one other thing that was in their power to deal with the crisis. They shifted the boundary between public and private, state and the market. Roosevelt dramatically increased the power of the federal government. Reagan decreased it. The problem they were addressing wasn’t the economic crisis itself, but a fundamental political crisis. In the 1929 depression, the financial elite had lost the confidence of the public. They appeared not so much corrupt as incompetent. Under Hoover, they were permitted to play out their hand, but then the situation got worse. Roosevelt intervened, shifting some of the power that had been in the hands of the financial elite to the political elite. Had he not done so, the sense that all the country’s elites had failed might have prevailed, a sentiment that led to fascism in places such as Italy and Germany.
The reverse happened under Reagan. In the 1980s, the political elite was perceived to be behind the economic crisis, and the public blamed the structure of “big government” left behind by Roosevelt. Reagan shifted the balance between the state and the market back the other way, weakening the state to strengthen the market.
Part of rebuilding confidence has to do with understanding which part of the elite—political, corporate, financial, media—is to be held responsible for the crisis. By essentially putting one set of elites or another into receivership, transferring their authority in many ways to other elites, Reagan and Roosevelt gave the public the sense that the president was acting decisively and taking power away from those who had failed. This eased the sense that everyone was helpless, and indeed cleared the way for at least some reforms that didn’t hurt, might have helped, and certainly were needed symbolically. In the end, the crises worked out both because of the underlying power of the United States and because of the resilience of the modern state and corporation, which cannot live apart, yet have trouble living together.
Neither Bush nor Obama was able to manage the national psyche as Roosevelt and Reagan had. Bush lost control of the war and was blindsided by the financial crisis. He fell behind the curve after Iraq and never caught up. Obama created expectations he could not fulfill, then failed to create the illusion that he was fulfilling them. But of course Reagan ran into similar problems at first. The issue that is unknown but that will affect the next decade deeply is whether Obama can recover and lead. Can he understand that when Roosevelt spoke about fearing fear, he meant that the president’s job is to appear to be effective whether or not he is? If Obama doesn’t learn that, the nation will survive. Presidents come and go, but this is a fragile time, with the legitimacy of the presidency and the country itself caught between the demands of republic and empire.
When we talk about shifting the boundaries between corporate and political elites and between the state and the market, this inevitably raises ideological issues. For the left, strengthening the corporate elite and the market threatens democracy and equality. For the right, strengthening the political elite and the state threatens individual freedom and property rights. It is an interesting debate to watch, save that the problem is not moral or philosophical but simply practical. The great distinction that prompts such heated ideological debate just isn’t there.
The modern free market is an invention of the state, and its rules are not naturally ordained but simply the outcome of political arrangements. The reason I say this is that the practical foundation of the modern economy is the corporation, and the corporation is a contrivance made possible by the modern state. The corporation is an extraordinary invention. It creates an entity that the law says is liable for the debts of a business. The individuals who own the business, whether a sole proprietorship or a huge publicly held entity, are not held liable for those debts personally. Their exposure can be no greater than their initial investment. In this way, the law and the state shift the risk from the debtors to the creditors. If the business fails, the creditors are left holding the bag. Nothing like this existed before the birth of “chartered companies” in the seventeenth century. Before that time, if you owned a business, you were liable for all of it. Without this innovation, there would be no stock market as we know it, no investment in start-ups, little entrepreneurship.
But this apportionment of risk is a political decision. There is nothing natural in the idea that the boundaries of individual risk are drawn where they are. Indeed, over time, these boundaries shift. The corporation exists only because the law created it. The political decision to create corporations also means that corporate law, not the law of nature, defines the precise boundaries of risk and liability. There may theoretically be some sort of natural market; but a market dominated by limited liability corporations, from the Fortune 500 to the local plumber, is inherently political.
