Global stock markets are in summer free-fall; the stocks and bonds of financial institutions are sinking more quickly than the Titanic; and sentiment is veering into panic territory. We have, of course, been here before, not necessarily exactly here, but close enough. In 1990-1991, banks also went into a tailspin, and before that there was the S&L crisis, and before that, the massive failures of the early 1930s, and then back into the regular bank panics and financial collapses that were endemic to the U.S. financial system for much of our history.
The prime question then and now remains the same: what precisely is the role and responsibility of the government to do something about all this? The tension of the free-market on the one hand and the responsibility of government on the other, the needs of the many versus the needs of the few, have never been resolved. While Washington and Main Street and Wall Street just now are in heated discussions and argument about what to do with the GSEs (the government sponsored entities known as Fannie Mae and Freddie Mac), underneath the policy plans is that unresolved issue of just how much government should do.
Some, and usually conservative, highlight the "moral hazard" problem: bail people out and the negative consequences of bad decisions are never born, which in turn facilitates bad behavior as surely as giving an alcoholic a drink. That was the crux of the debate over what happened with Bear Stearns in March of this year. On the other side, and usually liberals, are those who say that one of the primary roles of government is to step in when the free-market fails or when it manifestly allocates finite resources in such an unequal fashion that it creates both injustice and rifts in the precious social fabric that supposedly holds us together.
The technical questions surrounding the GSEs are real, and do need addressing even in the absence of explicitly dealing with the larger issues behind them. At stake are actual mortgages, actual credit creation, and the daily functioning of a vital aspect of the credit and financial system. No doubt something will be done to prevent their total collapse, although equity holders are likely to lose all of their money. But in crisis mode, government simply reacts, and there is no sign just now of a systemic consideration of the balance between government as a backstop or watchdog and the unfettered free market. We know that the unfettered free-market is a myth, but it holds a certain rhetorical appeal to many.
There are rumblings of a next wave of reforms that will adjust government institutions to deal with the new world of capital flows, derivatives, and contracts, as well as the unintended consequences of securitization. But little is being discussed about the ultimate goals, and there is little sign of the type of "first principles" debate that animated the creation of the Constitution, the establishment of the first central bank, the reforms of the New Deal, or even the underpinnings of the Reagan legislative agenda.
Government has a responsibility to provide for security, and economic security is surely a vital need, though usually a tad less acute than physical security. The past eight years have seen the entire public debate consumed with national security defined in military and police terms. Now, we are seeing that another dimension -- economic security -- has been almost completely ignored. Bailing out or not bailing out Fannie and Freddie is an important decision -- but it is tactical. In the upcoming fall election, let's hope both candidates turn more aggressively to the principles, without with there can be no good policies. Obama articulated a vision of government in the spring, and that is precisely what we will need to address these systemic issues in the years ahead.