June 03, 2020
(This piece originally ran on my Patreon page.) I see that my friend, David Dayen, is highly critical of the Federal Reserve Board’s bailout of corporate America. I’m afraid that I will have to disagree with him on this one.
Before going into details, let me briefly give my bailout credentials. I was one of the few progressive economists who was opposed to the 2008-2009 bailouts. I argued at the time that it would have been better to let the market work its magic on Goldman Sachs, Citigroup, Bank of America and the rest. This would have instantly downsized our bloated financial sector, eliminating an enormous source of waste in our economy by putting most of the Wall Street behemoths out of business.
At the time, it was fashionable among our elites to claim that this would lead to a Second Great Depression. This was utter nonsense. We learned the secret for getting out of a depression seventy years earlier at the start of World War II. It’s called “spending money.” A large enough stimulus package could have pushed the economy back towards full employment in fairly short order.
There is little doubt that if the big banks were allowed to fail, the immediate downturn would have been worse, but it would not have been as bad as the bank runs at the start of the Great Depression for the simple reason that we learned from those bank runs. We now have the Federal Deposit Insurance Corporation, which exists to ensure that banks can pay depositors and carry on other normal banking activity even after a bank has failed. Because we have the FDIC, as well as other safeguards, the idea pushed by politicians and the media, that we would have been unable to carry on normal business activity was utter nonsense.
And, there was an obvious moral/economic reason to allow the banks to go bankrupt, they had done this to themselves. The banks had issued trillions of dollars of dubious mortgages and packaged them into mortgage backed securities, collateralized debt obligations and other complex financial instruments. Their greed and incompetence put them in the situation where they faced bankruptcy. There was little reason not to let the people who had earned six, seven, and eight-figure paychecks during the bubble years enjoy the fruits of their labor. They should have lost their jobs and whatever holdings they had in these banks.
So, back in 2008-2010, I was firmly opposed to the bailouts. I wanted the Wall Street banks to pay the price for what they had done to the economy and the country. But there is a simple reason that things are different this time. The economic collapse was not the result of bad practices by major corporations, it was the result of a pandemic that none of them could reasonably have expected.
This is not to say that many of them were not engaged in bad practices. They were forking over far more of their profits to shareholders in the form of dividends and share buybacks than they were investing in new equipment and technologies. They also were paying CEOs, and other top executives, exorbitant salaries. These execs had little to show even by the narrow measure of providing good returns to shareholders.
But these bad practices were not the reason that companies found themselves on the brink when the pandemic struck. Even the best run airline was not going to be able to survive a 90 percent drop in traffic when the pandemic hit. The same applies to a wide range of other businesses who saw revenue plummet when the economy went into shutdown mode back in March. There would have been a massive wave of bankruptcies if the Fed had not stepped in to support financial markets.
Dayan notes that the Fed put no conditions on its loans, such as banning share buybacks or capping the paychecks of CEOs and other top executives. This would have been desirable, but Congress explicitly rejected putting these conditions in the CARES Act. It would have been difficult for the Fed to turn around and impose conditions that Congress had opted not to include in the bill.
Also, as the piece notes, much of the benefit of the Fed’s bond buying is going to companies where the Fed may not even be buying up their loans. The Fed’s intervention has boosted the bond and stock markets as a whole, since investors now know that the Fed is prepared to act to support financial markets.
I have long argued that we place too much emphasis on financial markets and that the cheerleading for a rising stock market is utter idiocy. But if the financial markets do go into a free fall, so that most companies are unable to raise capital, that is a real economic problem. We were facing this sort of situation back in March, when the Fed made its first major interventions to support financial markets.
Perhaps I’m being soft on Jerome Powell’s Fed because he moved the ball so much on monetary policy. Powell explicitly acknowledged what many progressives had long argued, that the Fed’s monetary policy very directly affects income distribution. When the unemployment rates get to very low levels, as it had before the crisis, it disproportionately benefits the most disadvantaged segments of the labor market.
African Americans, Hispanics, people with less education, people with criminal records and others who face discrimination in the labor market suddenly face much better employment prospects. And, the tighter labor markets also mean that these workers have the bargaining power to secure higher wages. This is in fact what we had been seeing the prior five years, as the tighter labor market was allowing workers at the middle and bottom of the wage distribution to see wage gains that exceeded inflation.
It was truly extraordinary to see the Fed chair as an ally in both pushing this view of monetary policy, and largely putting it into practice by allowing the unemployment rate to fall to levels that most economists had predicted would lead to spiraling inflation.
But apart from my view of Powell’s tenure at the Fed, it is still difficult for me to see how a Fed decision to stay out of financial markets in the pandemic would have made us better off. There are many moral and political takeaways from these actions.
First, Dayan is 100 percent right that, most immediately the Fed did save the hides of big share and bondholders. While this may have saved millions of jobs, it also means that the wealthiest people in the country turned to the government to keep them whole in this crisis. We must remember this fact in arguing for unemployment insurance, nutrition support, health care, housing assistance and other measures that will be needed to keep the bulk of the population whole in this pandemic.
It’s fair to say that investors could not anticipate this sort of disaster but neither could flight attendants, retail clerks, or restaurant workers. If the government is prepared to act to ensure that the richest don’t suffer as a result of the pandemic, it also better be prepared to protect those at the middle and the bottom of the income ladder.
The efforts to stabilize markets also put financial transactions taxes in a new light. Needless to say, many market makers and short—term traders stood to be wiped out by the market plunges that preceded the Fed’s interventions. If these actors can rely on the government to rescue them in a time of crisis, it is certainly reasonable to expect that they pay a modest fee in the form of a financial transactions tax as an insurance premium against such unanticipated disasters.
Perhaps most importantly, this is a vivid example of how the government sets the rules for determining who wins and loses in the market. It is more blatant in a crisis like this, but that is the way of the world. This is a lesson that every progressive should learn.