The Hindu Business Line : Keynes poised to come back?

Ironically, such bailouts in the past too occurred in free market and non-government intervention-believing Republican administrations, the famous example being the setting up of the Resolution Trust Corporation (RTC) to rescue Savings and Loan Associations in the late eighties when the current President’s father was in office.

Unbridled capitalism is not possible even in the only country in the world which has enshrined it. The only issue is when government must step in.

To be fair, the potential collapse of these mortgage giants had devastating implications for global investors in their bonds.

The oil and export billions of the West Asia and China have gone into their paper in huge amounts attracted by the spreads and backing of the US Government.

A hands-off approach would have not only ground mortgage financing in America to a virtual halt, but also generated shock waves in global financial markets if the two institutions defaulted on their debt-servicing obligations.

Deeper questions

With this, are we out of the woods? Wall Street greeted the move with a surge in the stock indices on Monday. But deeper questions remain.

Last Friday, the US reported a further fall in jobs in the widely-watched monthly non-farm payroll data. The unemployment rate crossed 6 per cent.

Property foreclosures because of falling prices and delinquent mortgages are increasing by the day. Consumer and business sentiment indices are hardly in recovery mode. So will the takeover of Fannie Mae and Freddie Mac make the difference?

The economy, clearly, is still in much distress. That is reflected in the continuing insipid data flow.

The problems of a weak economy are compounded by the inability and unwillingness of major banks to lend. New capital infusion is only restoring capital ratios, not improving them.

Thus, policy actions to arrest a financial market meltdown – the Fed’s rate cuts, liquidity support, the Bear Stearns rescue and now those of the two mortgage financial institutions – need (and will) not necessarily trigger a revival of the economy.

The hope must be for an autonomous recovery of house prices, engineering a turnaround. It could happen, but then again may not.

Time, then, to lever fiscal policy? Act I, consisting of tax cuts, is over and hasn’t had much effect. It was easy for a Republican administration to do it.

Act II might necessitate a specific government spending programme combined with a takeover of mortgages under water (i.e., collateral values less than loans) by a new RTC-type institution.

Keynesian economics could soon be back on the table.

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