Thursday, Jul. 09, 2009

Advice from an Economist Who Saw 1929

By Janet Morrissey

The Obama Administration should stop bailing out corporate disasters and abandon plans to move health care onto the backs of taxpayers.

Tough talk from Anna Schwartz, a financial sage who has seen it all, having lived through the crash of 1929 and co-authored with Nobel laureate Milton Friedman the highly acclaimed financial bible A Monetary History of the United States (Princeton University Press, 1963).

The financial matriarch has carefully tracked recessions, studied boom-and-bust trends and spent her life — all 93 years — mastering the intricacies of the monetary system and banking world. She's worked as an economist with the National Bureau of Economic Research since 1941 and now serves as an adjunct professor at the Graduate Center of the City University of New York. She recently spoke with TIME contributing editor Janet Morrissey. (See pictures of the stock-market crash of 1929.)

TIME: Is the recession approaching a bottom?
Schwartz: I think that when the final date for the end of the recession is determined, it will be shown that it occurred sometime in the spring of this year. But I don't believe the recovery will be very substantial, and therefore it's hard to say the worst is behind us. A lot will depend on how consumers behave. Consumers have been saving and not spending, and the absence of a big surge of this spending is what will prevent the recovery from being robust. In addition, in so many industries there is overcapacity. More firms are selling cars than there is a demand for cars, so somehow that overcapacity will have to be eliminated.

What do you think of President Obama's fiscal stimulus package in helping to turn the economy around?
The bill that provided something like $800 billion for spending on government projects was supposed to make people willing to spend their own money. But that hasn't happened. The implicit belief of the Obama Administration is that you needed fiscal stimulus [i.e., more government spending], and that's why they passed this enormous stimulus bill. But from my observation of how, historically, expansions have come to an end and how recovery has happened, it's always in terms of monetary stimulus. And that has not been the program of this administration.

By monetary stimulus, do you mean the Fed needs to print more money?
An increase in the money supply has historically always motivated people to spend and end a recession. And I don't know if there's any evidence that fiscal stimulus has the same effect on people's habits. All that Obama's fiscal stimulus bill has achieved is to put an enormous fiscal deficit on the Federal Government. (See pictures of the dangers of printing money.)

Do you think his PPIP [public-private-investment program] is a smart move in getting the toxic assets off the balance sheets of banks?
The premise that private investors would purchase these toxic assets on the assumption that as time passes, the value of these toxic assets will improve — I don't believe that. What the government is trying to do is to induce private purchase of these assets by subsidizing them.

And you don't agree with that?
I don't, no. I think these assets should be purged, and the only way to purge them is for the government to take them over and to relieve private holders [the banks] of these assets.

Should the government be bailing out troubled banks or letting them fail?
I'm opposed to the government bailing out firms that should be shut down because they are basically insolvent. A firm that's insolvent should be encouraged to file for bankruptcy and rid the market of an institution that's using resources that could be better used by productive firms.

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Are you just talking about financial institutions or companies in general, such as GM?
It applies to any kind of firm that isn't solvent. It doesn't matter if it's a car producer, an industrial firm or a financial firm. It should be encouraged or even compelled to file for bankruptcy. When you keep on bailing out institutions indiscriminately, there is no incentive for them to be prudent in what they're doing, because they know that whatever they do, whatever problems they create by their own behavior, the government will come along and bail them out. So you are providing incentives for institutions to operate in a way that will only increase the opportunities for firms to behave in an unacceptable manner. The government's [bailout] actions will make the economy less productive and less prudent. (See the 50 worst cars of all time.)

So you think the auto industry should not have been bailed out?
If GM was on the verge of bankruptcy, it should have been shut down. There's all this capacity in the production of cars, but there isn't a market that can absorb all that these firms are prepared to produce. If jobs are lost, then jobs are lost because these are firms that cannot exist, because there is insufficient market demand for their product. And if there is no such market demand, they should not be allowed to exist. Let the market decide if these firms deserve to exist. Government should not be the one who's the arbiter.

There's much debate over proposed health-care reforms. Is Obama on the right track?
The trouble with Obama's plan is that he has no concept of the cost that he will be imposing on the economy if his program is actually enacted. He's spending money with the stimulus program — all kinds of programs — and he's always able to give excuses on why the money should be spent. Yet despite all of his rhetoric, Obama isn't really taking care of the budget ... I don't think the government's job is to provide health care — the private sector is the proper provider. He has no concept of what he is demanding of the private sector [or] of how much it will cost in the way of limitations on the health care that will be available because of the government's intervention. (See 25 people to blame for the financial crisis.)

When you say limitations, do you mean the quality of health care won't be as good?
The quality, the incentive to provide innovations in health care, will all be in danger by the government's intervention. A lot of people in Canada cannot get ordinary [surgical] procedures because there's a limit on what the government provision of health care allows. So people are lined up for years to get ordinary procedures that in America are just routine. You can get a hip replacement [here] without waiting for years, and you don't have to be a celebrity on a list to get immediate health care.

What about the battered housing sector? Has Obama done enough to help this sector?
It was the government's program to promote homeownership that permitted all of the excesses that occurred over the years. People who should never have had a mortgage were induced to buy a home when they couldn't pay for it. And as a result, those are the ones whose homes are being foreclosed, and the whole economy is affected.

Should more steps be taken to stop the foreclosures? Or would it be better for the foreclosures to proceed?
One of the things that can be done to make the housing market more stable is if something is done to limit the foreclosures. There's been a lot of rhetoric about helping mortgage holders who cannot maintain their monthly payments on the mortgage, but very little, in fact, has been done to help them. If they've really got a program now that will work, that will help to stabilize the housing industry, and that will improve chances for a revival of the economy.

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