In my time here, what I want to do is to bring you a message of hope and change.
The title of my talk in the program is something along the lines of the Bush-Obama bailout
will permanently change the nature of American capitalism.
That's the change part.
And the hope part is, I hope it's not true.
I want to talk about, actually a little bit broader than the bailout, I want to talk about
economic policy that's occurred over the past year.
And it's almost breathtaking.
It's hard to talk about and I think maybe in five years' time we'll look back and see
things a little differently.
But a year ago it would have been hard to imagine all the things that we've seen in
in the past year as far as changes in economic policy and I am fearful that these changes
will fundamentally change the nature of American Capitalism in a manner similar to the way
that we look back and think about the New Deal or to a lesser extent the Great Society.
There are four particular aspects of policy I want to talk about.
The role of the Federal Reserve, the TARP program, the stimulus package, and bailouts.
Let me start with the Federal Reserve.
For decades, I've taught my students about what the Federal Reserve Bank does, and essentially
the main thing that the Federal Reserve Bank does is control the size of the money supply
through Open Market Operations, or at least that's what I've taught for decades.
And they do that by buying and selling government securities.
And that's changed.
Over the last year, the Federal Reserve has started buying non-government securities,
something completely new and a major change in policy and something I don't see the press
picking up on.
And the second thing the Federal Reserve does, to a lesser extent now, but this is really
The Federal Reserve was created in 1913 to make loans to member banks.
Banks that are members of the Federal Reserve system can go to the discount window and borrow against their assets.
And a major change has occurred over the last year.
The Federal Reserve is making loans to other financial institutions, non-bank financial institutions.
These are two huge changes in Federal Reserve policy that I don't think have been sufficiently noted.
People have talked about the huge increase in the financial base over the last year.
Yep, that's real.
But the bigger policy change over the long run, I think, when you look at Federal Reserve
policy is they're buying non-government assets instead of federal bonds, federal government
bonds like they used to, and they're extending loans to institutions that are not member
banks of the Federal Reserve system.
This has all the makings of setting the Federal Reserve Bank up as a designer of industrial
policy in the United States, at least prior to what the last year's policies, the Federal
Reserve was relatively neutral as far as its treatment of various industries and businesses
in the economy.
Yeah, it could create a lot of inflation by expanding the money supply, but it did so
in a neutral way by buying and selling government securities.
When it's buying securities that are non-government securities, it's essentially picking and choosing
who it's going to support.
And that has the makings, the very foundation of setting up an industrial policy and making
the Federal Reserve an agent of industrial policies.
Very troubling.
You know, that's the change part.
The hope part is, I hope it's not true, but I'll talk a little bit more about that hope
part at the end.
I'm going to end on a hopeful note, I promise.
But it's troubling to see the change in the Federal Reserve Bank over the last year.
And in my title, I deliberately obviously titled this the Bush-Obama policies.
Ben Bernanke is a Bush appointee and these policies started in the Bush administration.
So regrettably, the policies we're looking at today, the policies I'm talking about right
now are bipartisan policies.
We can't say it's because we now have a democratic majority or a democratic president.
These things were started under President Bush.
Second thing I want to talk about is the TARP program.
Y'all remember when Secretary Paulson announced that the financial system was in such crisis
that we immediately need $700 billion essentially to be spent at the discretion of the Secretary
of the Treasury.
The argument they argued was the $700 billion would go toward buying these so-called toxic securities that we needed to get them off of the balance sheet of the banks and so forth in order to restart the financial system.
Now, in hindsight, was this argument correct? We can see it wasn't because that's not what the money was used for.
Actually, Paulson and Bush rushed this thing through Congress, pressured Congress to pass
this $700 billion emergency package to buy those toxic assets.
The legislation essentially left the disposition of that $700 billion to the Secretary of the
Treasury, and they did look pretty hard at how they could buy up those toxic assets.
I actually have a significant number of economist friends who were hired as consultants to the Treasury Department
to try to come up with an auction scheme to buy those assets.
But I think they decided it just wasn't feasible to do it.
But whatever, they didn't do it.
Instead, what they've used the money for, about half of it up to this point,
so there's still another $350 billion pending,
but what they used the money for was to take equity interest in banks.
Banks, this is not what the TARP originally was, I mean that wasn't what they said they
were going to use the money for, but instead they've used it to take equity interest in
banks and so now as you know, the federal government owns a significant equity interest
in a lot of large banks.
One result of that is in the popular press, you've seen discussion about the nationalization
of Banks, and sure enough, when the federal government owns a big share of these banks,
you know, what else might we call it but the nationalization of banks? And of course, that's
troubling too, and it goes right along with the Federal Reserve policy. If the federal
government is the owner of the banks, then who's going to get the loans? Who's going
to be financially supported by those financial intermediaries? What's up to the federal government?
So again, we're moving in the direction of industrial policy as the federal government
takes over our financial system.
I hope it's not true.
You know, and what they say, you know, what we can hope will happen is that the federal
government, they plan to divest themselves of this equity interest when the financial
system gets back on sound footing, but I mean, you can see where this might be headed.
You know, where essentially the federal government sort of through the back door here, but controlling
financial institutions ultimately decides which businesses are going to get loans, which
industries are going to be supported and so forth.
You know, very troubling, very troubling.
The third issue I wanted to talk about was the stimulus package.
I think so much has been said about this.
We don't need to talk about it in too much detail, but when you look at the Keynesian
justification for the stimulus package, more government spending, boosting aggregate demand
and so forth, but you look at what the money is being spent for, and really if you go back
and you look at President Obama's campaign rhetoric about where he wanted to spend money,
where he thought the federal government should get more involved, that stimulus bill looks
It's a lot like the fulfillment of President Obama's campaign promises.
He was able to get those things passed through Congress under the guise of it being a stimulus
package, but most of that money isn't even going to be spent in 2009.
Current forecasts seem to suggest by 2010, a year from now, the economy will be recovering.
We won't need the stimulus, but the money already is going to be appropriated.
So, you know, it's not really a stimulus package at all, it's the advancement of President
Obama's agenda for greater federal government involvement throughout the economy.
Now, I might step back and say, the whole idea behind this stimulus package, the Keynesian
One idea behind the stimulus package is that if you increase aggregate demand by increasing
government spending, by cutting taxes, and 95% of you people are going to get a tax cut,
but that's the whole part.
But if you look at the logic of that, what that would suggest is if we increase spending
and cut taxes, raising the deficit, that's going to increase aggregate demand and lead
When President Bush took office we had a surplus in the federal budget. If in fact increasing government spending and cutting taxes raising the deficit, if that would stimulate the economy and lead us to prosperity, we ought to be in nirvana now.
Now, I mean, you know, after the huge and increasing deficits of the Bush administration.
But nevertheless, that's the approach that we're taking to stimulus today.
So ultimately, what that stimulus package is going to do is going to build in another
five percent or so of GDP into government spending.
And we're going to have a permanently larger public sector as a result.
I hope it's not true, but it's hard to see how you're going to reverse that government
spending once it gets into place, to the point where even some politicians see this.
I think there's at the moment four state governors who say they're not taking the stimulus money
from the federal government because it's coming with strings attached, and once that stimulus
money runs out, the states are going to have to foot the bill, either that or kick a bunch
and a bunch of people off Medicaid and welfare programs and so forth.
And those governors rightly see, you know, once the state is supporting these people,
it's going to be very difficult politically to move back on that.
So, you know, again, it's very troubling.
The fourth thing I want to talk about is the bailouts.
And, you know, we see the bailouts of these financial firms.
I guess we've talked a little bit about that already under the guys of the TARP program and so forth.
We're in the process of bailing out the automobile industry, Chrysler and General Motors.
And again, I mean, this is very troubling. I mean, it's just elementary economics that the way the market system works
is based on the incentives provided through profits and losses.
If a firm takes resources and combines those resources and produces output that's worth
more than the resources it used to produce that output, that's a good thing for all of
us, right?
Because it's increasing the value of resources.
So these firms that take resources and combine them into output that's more valuable than
the resources they use, we should reward them for that because they're doing a great thing
for our economy.
In fact, the market system does reward firms for that. That's what profit is.
And if firms take resources and combine them into output, and the output is worth less than the resources that they use to produce the output,
that harms the economy. And we should penalize firms that do this.
And the market system does that. That's what losses are.
When President Obama was campaigning last summer and gas prices were up over $4 a gallon, he said one of the things he was going to do was to put an excess profits tax on the oil industry.
Now, if gas is $4 a gallon, you'd think that people would want more gasoline, and that we would be inclined to reward firms that would provide it to us, but President Obama's idea is, no, we should penalize them, put an excess profits tax on them.
And now, when the auto industry is struggling, the policy is to reward those firms that are squandering our resources, taking big losses.
So we've got a policy put in place, now we actually, gas prices are down and so President Obama's backed off on his excess profits tax for the oil industry,
But nevertheless, and it was part of his campaign, you know, essentially we've announced a policy where if firms are successful and productive and making profits, we're going to penalize them, and if firms are unsuccessful and losing money, we're going to subsidize them and support them, right?
We're doing that with the auto industry, of course, you know, all the financial institutions, all those bailouts.
This is a policy that's going to be exceedingly hard to reverse because the economy will recover, firms are going to start to make profits again, but we've set the precedent for subsidizing failing firms and at least announce the policy of penalizing successful firms.
I just recently re-read Atlas Shrugged. I'm sure most of you are familiar with it.
It's a 50-year-old book, but you read through it, and it's like you're reading current events.
It's a little bit eerie. So you look at what's happened over the last year,
last year, and it's really, it's just mind boggling and breathtaking when you look at
these policies, the Federal Reserve policy, TARP, the bailouts, the stimulus package,
you put this all together and these programs have the potential to fundamentally undermine
the market system, the capitalist system that we know now.
They have the potential to be as substantial a change in our economic system as the New Deal.
That's the change part. I hope that's not true. I hope that's not true.
And let me tell you why I'm a little bit optimistic.
I would hope we can reverse these policies.
I hope. I mean, you know, that people will see, look at what the guy is doing. Yeah, he talks a good game.
Our first indication of that, I think, is going to be the midterm elections coming up a little bit less than two years.
I think that will be a referendum on Obama's policy, so it'll be interesting to see.
The reason why I'm hopeful really doesn't have anything to do with current conditions, but more past conditions.
I really don't feel good about what's going on right now with regard to federal government policy.
But I've had this feeling before. Like, I'm old enough, I've been around enough, I've had this feeling before.
When was the last time I had it? It was about 30 years ago. Let me go back 30 years ago, 1979.
President Carter was in office. Carter had, one of the things he ran on was the so-called Misery Index,
which is the sum of inflation and unemployment.
He says, you know, I mean, look at the misery index, how high it is under President Ford,
that when you add together inflation and unemployment.
When Carter was running for re-election four years later,
the unemployment rate was higher than when he got elected,
and the inflation rate was higher than when he got elected.
For some reason, Reagan never mentioned the misery index in the campaign.
Carter made such a big deal about it.
We had periodic gas lines because we still had a legacy of Nixon's wage and price controls.
The price controls were still on gasoline.
We still had periodic lines at the gas pump with a stagnating economy.
We had American hostages in the American embassy in Iran, you may remember.
And for those of you that do remember the 70s, you probably also remember
Polyester Leisure Suits and Disco Music. So the decade was just...
There's a lot of negative things about the seventies.
And there was good reason to be pessimistic, and I didn't feel too good about things in 1979, thirty years ago.
But other people didn't also.
And when President Reagan was elected in 1980...
Do you remember when President Reagan was elected in 1980, the highest marginal income tax rate
was 70%. I keep this in mind, sometimes people say things aren't politically feasible. Well, as an academic, I don't really need to worry about that myself anyway. But when Reagan was elected, the highest marginal income tax rate was 70%. In 1989, after Reagan had left office, the highest income taxpayers paid a marginal rate of 28%. If you're in the highest income tax bracket, your marginal rate fell from 70% to 28%. If you'd asked me in
1980. Would that be possible that we could see that kind of decline in marginal tax rates?
I would have said no. Now, if you ask me if things are possible, you know, I say, well,
I'm an academic. I don't worry about that. But there's an example where something that
seems like politically this just wouldn't be possible. It happened. We had a prosperous
The first decade in the 80s, 1989, 20 years ago, the Berlin Wall fell, move up to 10 years ago, 1999.
It's the end of the Clinton administration, but we had a prosperous economy, we had a federal budget surplus.
So my reason for optimism really isn't anything about looking at current conditions.
I wish I could point to something in current conditions and say you know I hope things turn around but rather it's looking back 30 years ago to 1979 and what things looked like there and there was a backlash and the ideas of liberty came to the forefront and I'm hopeful that will happen again I think there's some reason for pessimism but I'm an optimist by nature and though I don't
I don't see what the grounds for hope is, historically I see things can change and I'm optimistic we can turn this around.
If not, I seriously believe what we've seen happen in the last year will fundamentally change the nature of American capitalism.