focus - Is America too BIG TO FAIL?

IN THE NARRATIVE that has governed American commercial life for the last quarter-century, saving companies from their own mistakes was not supposed to be part of the government’s job description. Economic policymakers in the United States took swaggering pride in the cutthroat but lucrative form of capitalism that was supposedly indigenous to their frontier nation.
Through this uniquely American lens, saving businesses from collapse was the sort of thing that happened on other shores, where sentimental commitments to social welfare trumped sharp-edged competition. Weak-kneed European and Asian leaders were too frightened to endure the animal instincts of a real market, the story went. So they intervened time and again, using government largess to lift inefficient firms to safety, sparing jobs and limiting pain but keeping their economies from reaching full potential.
There have been recent interventions in America, of course — the taxpayerbacked bailout of Chrysler in 1979, and the savings and loan rescue of 1989. But the first happened under Jimmy Carter, a year before Americans embraced Ronald Reagan and his passion for unfettered markets. And the second was under George H.W. Bush, who did not share that passion.
So it made for a strange spectacle last weekend as the current Bush administration, which does cast itself in the Reagan mold, hastily prepared a bailout package to offer the government sponsored mortgage companies, Fannie Mae and Freddie Mac. The reasoning behind this rescue effort — like the reasoning behind the government-induced takeover of Bear Stearns by JPMorgan Chase just a month before — sounded no different from that offered in defence of many a bailout in Japan and Europe:
The mortgage giants were too big to be allowed to fail.
Big indeed. Together, Fannie and Freddie own or guarantee nearly half of the nation’s $12 trillion worth of home mortgages.
If they collapse, so may the whole system of finance for American housing, threatening a most unfortunate string of events: First, an already plummeting real estate market might crater.
Then the banks that have sunk capital into American homes would slip deeper into trouble. And the virus might spread globally.
The central banks of China and Japan are on the hook for hundreds of billions of dollars worth of Fannie’s and Freddie’s bonds — debts they took on assuming that the two companies enjoyed the backing of the American government, argues Brad Setser, an economist at the Council on Foreign Relations.
Commercial banks from South Korea to Sweden hold investments linked to American mortgages. Their losses would mount if American homeowners suddenly couldn’t borrow. The global financial system could find itself short of capital and paralysed by fear, hobbling economic growth in many lands.
Nobody with a meaningful office in Washington was in the mood for any of that, so the rescue nets were readied. The US treasury secretary, Henry Paulson Jr., announced that the government was willing to use taxpayer funds to buy shares in Fannie and Freddie. The chairman of the Federal Reserve, Ben Bernanke, said the central bank would lend them money.
The details were up in the air as the week ended, but some sort of bailout offer was on the table — one that could ultimately cost hundreds of billions of dollars.
Whatever the dent to national bravado, or to the freeenterprise ideology, the phrase “too big to fail” suddenly carried an American accent.“Some institutions really are too big to fail, and that’s the way it is,” said Douglas Elmendorf, a former Treasury and Federal Reserve economist who is now at the Brookings Institution in Washington. “There are no good options.” Still, there are ironies.
Since World War II, the US has been the centre of global finance, and it has used that position to virtually dictate the conditions under which many other nations — particularly developing countries — can get access to capital. Letting weak companies fail has been high on the list.
Mr Paulson, who announced the bailout, made his name as chief executive of Goldman Sachs, the Wall Street investment giant, where he pried open new markets to foreign investment. As treasury secretary, he has served as chief proselytiser for American-style capitalism, counseling the tough love of laissez-faire.
In particular, he has leaned on China to let the value of its currency float freely.
All through Japan’s lost decade of the 1990s and afterward, American officials chided Tokyo for its unwillingness to let the forces of creative destruction take down the country’s bloated banks and the zombie companies they nurtured. The best way out of stagnation, Americans counseled, was to let weak companies die, freeing up capital for a new crop of leaner entrants.
But as Japan’s leaders engaged in bailouts and bookkeeping fictions to keep banks and companies breathing, they offered those words of justification now heard here: The companies were too big to fail.
In 2002, the government engineered the rescue of Daiei, a huge, debt-laden grocery chain. In 2003, it injected some $17 billion into Resona Bank to keep it upright. Each time, Japan’s leaders said failure was not an option.
Today, among strict adherents of laissez-faire economics, the offer to bail out Fannie and Freddie is already being criticised as a trip down the Japanese path of putting off immediate pain while loading up the costs further along.
For one thing, this argument goes, taxpayers — who now confront plunging house prices, a drop on Wall Street and soaring costs for food and fuel — will ultimately pay the costs.
To finance a bailout, the government can either pull more money from citizens directly, or the Fed can print more money — a step that encourages further inflation.
“They are going to raise the cost of living for every American,” said Peter Schiff, president of Euro Pacific Capital, a Connecticut-based brokerage house that focuses on international investments More News :