The Financial Crisis: Past, Present, and Future
The logic of needing to save Wall Street in order to save Main Street is a difficult, though necessary, argument to make asserted David Wessel, the Economics Editor for The Wall Street Journal, at a Wilson Center on the Hill event on April 27th. Calling this a "moment of great rebalancing", Wessel argued that the U.S. had been told for years that it did not make things as cheaply as China or as well as Japan, but could take solace in the fact that it knew how to run a financial system. The 2008 financial crisis certainly proved that assumption false. At the event, Wessel discussed the financial crisis in the context of where we have been, where we are now, and where we are going. In his introduction, Program on America and the Global Economy Director Kent Hughes, highlighted the relevance of the discussion, particularly emphasizing the role of Congress in settling on financial reforms.
Wessel began by suggesting though the signs of an impending financial crisis were not entirely clear, economic forecasters should have done a better job of foreseeing the impending meltdown. However, with a regulatory process that has different people focusing on different parts of the financial process and not communicating effectively, gaps are easily created. With the proliferation of new and sophisticated financial products such as synthetic collateralized debt obligations, these gaps have become harder to close. Combined with the Fed's decision to keep interest rates low for so long, Wessel argued that the conditions were ripe for a severe financial crisis.
According the Wessel, since the crisis began, the federal government and the private sector alike have struggled to come up with solutions to the enormous problems created by the financial meltdown. From the bailout of financial giant AIG, to the decision to let Lehman Brothers go bankrupt, the federal government has been struggling to adopt a strategy that would stabilize financial markets and facilitate renewed lending. Wessel was confident that, due in part to strategies enacted thus far, the economy and global markets and industries would rebound.
While Wessel expressed hope that global markets would rebound, he noted that state and local governments are still in crisis stage. With 49 of the 50 states required to balance their budgets, states and local governments are cutting spending and raising taxes – off-setting some of the impact of the American Reinvestment and Recovery Act (also know as the stimulus bill). With the unemployment rate then at 9.7 percent, housing and stock prices down, and the financial markets still uncertain, Wessel added that the American people are increasingly anxious about the economic future and what steps, if any, the federal government could take to improve the economy.
Reflecting on the difficult realities of the current situation, Wessel outlined three important considerations for the federal government. First, he said timing is everything. Removing help too soon may cause a deepening or new recession. Secondly, over-stimulating the economy may lead to inflation. Lastly, Wessel acknowledged that any action will be extremely difficult and perhaps divisive in this harsh political climate.
Looking to the future, Wessel argued that institutions like the Federal Reserve will need to consider the lessons learned from the financial crisis and how they should be applied to future problems. However, Wessel also noted that there is little consensus within the Fed regarding what these lessons were, and even less agreement about what actions should be taken.
One lesson Wessel would like to see learned is the need for a resolution authority that could deal with large financial institutions that are currently viewed as too big to fail. When asked how Congress should respond in the wake of the crisis, Wessel said that this session of Congress should not end without some meaningful reform of the financial regulatory system. Wessel closed by arguing that the U.S. has seen the results of an ineffective regulatory system and should realize that reforming the financial regulatory system is of the utmost importance.
By: Shelley Harriman
David Klaus, Consulting Director, Wilson Center on the Hill
Kent H. Hughes, Director, Program on America and the Global Economy