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December 3, 2007

Treasury Secretaries Then and Now

Markets seem to be calmer today after Senator Dodd spoke about his meeting with Fed chair Ben Bernanke and Treasury Secretary Henry Paulson:

Fixing the Credit Crunch, by John Godfrey, WSJ Washington Wire: Senate Banking Committee Chairman Christopher Dodd said Federal Reserve Chairman Ben Bernanke promised to use “all the tools available” to respond to volatility in the nation’s financial markets.

Dodd, a ... Democrat ... met with Bernanke and Treasury Secretary Henry Paulson ... to discuss the recent volatility in the financial markets and the broader implications for the U.S. economy. Dodd said he also spoke with Paulson and Bernanke about possible additional steps that can be taken to help stabilize mortgage and financial markets and help homeowners nationwide. “I expressed the need for both the Fed and Treasury to use all the tools at their disposal to keep our markets working and so that the business and consumers can have the funds to prosper,” Dodd said.

“Chairman Bernanke agreed,” Dodd added. He, however, was frustrated with Paulson’s unwillingness to consider increasing the portfolio caps at Fannie Mae and Freddie Mac. “The power exists today with the regulator to lift those caps,” Dodd said. ...

But there's something odd here. Normally, it is the Treasury Secretary's job to issue statements to calm the market, not the chair of the Senate Banking Committee, but for some reason Paulson has been ineffective. If anything, it seems like markets panic further when he talks which may say something about the credibility of loyal Bushies, even those who have been at Goldman Sachs. It's also a bad sign that Paulson’s free market ideology is getting in the way of the Treasury Secretary taking Bernanke's advice to lift the caps at Fannie Mae and Freddie Mac, so perhaps the markets indifference or negative reaction to his statements is justified.

To see the difference between how past Treasury Secretaries reacted in the face of a financial crisis and what we have now, recall "The Committee to Change the World" comprised of "The Three Marketeers," Robert Rubin, Larry Summers, and Alan Greenspan that came into being after the LTCM crisis in the late 1990s:

The Three Marketeers, by Joshua Cooper Ramo, Time Asia, 2/15/99: ...Although the U.S. economy has been nothing but sunshine, it has been a terrifying year in world markets: famed financier George Soros lost $2 billion in Russia last year; a hedge fund blessed with two Nobel prizewinners blew up in an afternoon, nearly taking Wall Street with it; and Brazil's currency, the real, sambaed and swayed and then swooned. In the past 18 months 40% of the world's economies have been tugged from robust growth into recession or depression.

So far, the U.S. has dodged these bullets, but the danger to its economy is far from over. ... In late-night phone calls, in marathon meetings and over bagels, orange juice and quiche, ... three men--Robert Rubin, Alan Greenspan and Larry Summers--are working to stop what has become a plague of economic panic. ...

The three men trying to cope with these mid-ether collisions of dollars and expectations are an unlikely team. ... Greenspan has a theory about what holds them together: "In analytical people self-esteem relies on the analysis and not on the conclusions." ... The three men have a mania for analysis that has bred a rigorous, unique intellectual honesty. In the Reagan Administration economic policymaking was guided not by analysis but by conclusions--specifically a belief in so-called supply-side economics. No matter what the data showed, the results among Reagan-era economists like Arthur Laffer were always the same: tax cuts and less regulation were the solution. Rubin, Greenspan and Summers have outgrown ideology. Their faith is in the markets and in their own ability to analyze them. "It's unusual," Greenspan says. "In Washington usually you come to the table, and everyone meets, and no one changes their mind. But with us, you have something else." ... So despite different political backgrounds, they have the ability, rare in Washington these days, to preclude partisan considerations from their discussions. ...

Rubin has had his star turns... In late 1997 he probably single-handedly stopped a panic about Korean debt from avalanching into a U.S. market crash by working the phones, convincing international bankers that they should cut Korea a break. It was not a welcome pitch. "This is a hell of a Christmas present," one banker moaned to Rubin on Christmas Eve. But Rubin's scheme saved the banks billions because if Korea had crashed, the banks could have lost everything. "It was Bob who actually got the banks to see how it worked to their benefit," Greenspan explains. ...

That was then, this is now:

Paulson brings laissez-faire approach on financial crisis, by Steve Weisman. IHT:  What happened to the Hammer?

After decades at Goldman Sachs, where his nickname came from his aggressive deal making, Treasury Secretary Henry Paulson Jr. was hailed last year when he took office as someone especially well equipped to handle potential crises in markets.

But the financial disorder this August has brought few public appearances and only general reassurances from Paulson on economic fundamentals, while he has left it to the Federal Reserve to act. There has been no talk of bailouts, policy changes on federal regulations or other actions to stem the contagion in global markets.

"I don't believe that more regulation of private pools of capital, or more regulations or laws in general, would insulate investors from losses or would be effective," Paulson said... "I don't think it's constructive right now in the middle of this market turmoil to start pointing fingers and making specific policy recommendations." ...

Paulson said that he was generally loath to make as many public comments about the market situation as some may want, but he felt that circumspection was more in keeping with his style.

"My view from the day I came down here was not to talk unless I had something to say," Paulson said, acknowledging that he has been reluctant to make public pronouncements during the current instability. ...

Treasury officials ... say Paulson understood from the outset that his time in office might be defined by a crisis that no one could foresee, the way that Treasury Secretary Robert Rubin's almost mythical reputation for effectiveness was cemented by his handling of the debt crises in Mexico and Asia in the 1990s. ...

As the crisis of the mortgage markets has spread to wider credit markets and stock markets, associates of Paulson say his instincts would be to oppose an administration role in a bailout of a private institution, the way the Federal Reserve Bank of New York organized a rescue of the hedge fund Long-Term Capital Management in 1998. ...

Since he hasn't talked much, and says he keeps quiet unless he has something to say, it doesn't sound like he has any policies to offer anyway, so that may explain the silence. Somehow, I think Rubin and Summers would have had something to offer to help us understand the problem, the possible responses to it, and to calm markets in the process.

One thing potentially getting in the way here is ideology. If you believe that markets work, or are best left to fix themselves when they don't, then you don't have much to say when a crisis hits other than to tell people to be patient while the problem fixes itself.

Contrast this to the thinking in the past. From the Time article:

If markets work so well, why were they burning their vacations on the phone ...? The problem, the men say, is that the markets are encumbered by all kinds of imperfections. Even tiny flaws create problems. ...

That recognition - that markets can and do fail - allows much more flexibility in how to respond. The "Three marketeers'" favored market-based solutions whenever possible, but they at least acknowledged the possibility that markets do not always operate perfectly. On this point, I'll admit some surprise that Greg Mankiw's "Top Three Economic Concepts" includes "Market failure, such as externalities, and the role for government," and his conclusion that:

The lesson is that we can all gain from economic interdependence and that markets are a good, but not always perfect, way to coordinate people in an interdependent world.

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