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The Right Questions

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Thomas Pynchon said something like: if they get you asking the wrong questions, they don't need to worry about the answers.

With so many aspects of our current economy in trouble, we find ourselves back in the midst of that great debate over government's role in the economy. The problem is, we risk answering the wrong questions. Or, to be more precise, we risk not going nearly far enough in probing what's right and wrong with the American economy.

It is widely agreed that the pendulum has swung too far toward deregulated market fundamentalism. Market failures abound, and enough people have a sense that these failures are connected to their current stressors, from job losses to gas prices, that the status quo is under the microscope, if not on the run.

President Bush, a fierce adherent of YOYO (you're on your own) for the masses, socialism for the rich, is about to sign the new housing bill, with all its market corrections, including a taxpayer funded lifeline to Fannie and Freddie (if they turn out to need a solvency infusion). Hank Paulson, the Treasury Secretary, has been advocating for more market interventions than a rabid Keynesian. The FDIC is spending its weekends arranging takeovers of failed banks, and the Federal Reserve, when they're busy with their own takeover matchmaking, is inventing new government-backed funding tools well beyond anything they've undertaken in the past.

The reaction to all this by the chattering classes, including yours truly, has been interesting as well. Bob Davis et al at the WSJ provide a useful overview, but it's in the opinion writing that you get the real sense of unease caused by all this market intervention. There may be a few true Milton Freidmanites out there ready to let even the alleged "too big to fail" institutions go down, but there are mostly nervous middle-grounders and faux fundamentalists.

The latter talk the anti-interventionist talk, but when the chips are down, they call for a lifeline from the government. I debate them on CNBC with great regularity. They endlessly tout the virtues of unfettered markets, demand endless deregulation, while constantly nudging the Fed to lean one way or the other, insisting that the government to "support the dollar" (see Wall St. Journal oped page), and, most recently, reluctantly agree to the taxpayer funded bail outs.

The nervous middle-grounders, like Roger Lowenstein over at the Times today, agree that we maybe need some new rules, but worry that as long as the government is underwriting risky investors, those investors will escape the market discipline so fundamental to the system.

That sounds reasonable, but doesn't really help anyone draw the line. All economies, advanced or otherwise, will experience market failures, and government will be tapped to offset them, which is as it should be. Lowenstein writes "The government should get out of the business of assuming risk..." But, as Peter Gosselin writes in his must-read new book, High Wire, government at its best has assumed all kinds of risk, from pension risk (Social Security), to market risk (SEC, Federal Reserve, FDIC), to medical risk (Medicare), to environmental risk. Government at its worst has ignored (most recently, market risks) or exacerbating these risks (environmental).

Obviously it's a balancing act, but instead of complaining about vagaries, we need deeper thoughts about what went wrong and what it will take to reset the balance between government and market risk. As I said in this space last week, the time to worry about moral hazard is not the weekend when the bank is failing. It's now, when many in the public, along with policy makers from both sides of the aisle are connecting the dots between failing markets and the economic pain caused by job and wage losses, the housing bust, the energy crunch, and the financial market turmoil.

In testimony last week, I ticked off a bunch of ideas -- not all my own by any means; most of this is conventional wisdom -- to re-regulate financial markets, and these ideas were well received by the members of Congress on the Joint Economic Committee. But, having read a bunch of the analysis, including my own, I have a nagging feeling that we're missing the big picture.

We're arguing about slight moves down a continuum, necessary moves designed to offset the bubble and bust economy of the past few cycles, and inject some overdue oversight needed to ratchet down obvious excesses, like the trashy loan practices in the subprime housing market, or the off-balance-sheet entities held by investment banks. It's a measure to just how limited our debate has become that even these moves bring cries of "French socialism," the end of Reaganism, with accompanying visions of the invisible hand in shackles.

All that any of this re-regulation will do, if it works, is to diminish damaging excess. If it prevents bubbles from inflating, it will keep the macro-economy more on track. These rules might prevent some bank failures and unscrupulous lending; they might provide some transparency that investors need to price risk.

They won't reconnect the living standards of the middle class to the growth in the economy. They won't reverse the slide in health and pension coverage. They won't lift the bargaining power of workers unable to claim their fair share of growth they themselves are creating. They won't get us any closer to the investments we need to make in our children, our environment, our public infrastructure. They won't rebalance the risk shift that underlies much of today's economic insecurity.

They'll make the gears deep inside the machine of capitalism turn more smoothly, and that is a good thing. But the question is, what comes next? Once we get a little common sense back into the system and hopefully shut down the bubble machine that's characterized the last few cycles, will we take the steps to craft the economy we want? Will we do everything we can to ensure the occurrance of that which has eluded too many for too long: broadly shared opportunity and ultimately, prosperity?

These are the questions we should be asking McCain and Obama over the next few months. And the one with the right answers deserves first, your vote, and second, your scrutiny to make sure they walk the walk once they win.