What to Do Now?

I agree with Yuval Levin and Noah Millman that increased transparency and oversight are desirable and likely modifications to the proposed financial bail-out plan. There may well be even more substantial changes to it over time.

We are extremely likely to put in place regulatory, legal and other structures that we come to regret later. I wrote an article in National Review last year about how, on the back-end of the tech bubble a few years ago, we did exactly this. There are reasons why we always do this after a bubble bursts.

But we are now in a position of choosing among unpleasant alternatives.

Consider the situation on Thursday morning. A run was happening in money market accounts – not “threatening to occur”, but actually happening. Failure to intervene at that moment would have been disastrous. This is one reason that one less-discussed feature of the bail-out plan is the federal guarantee for money market accounts. The intervention had to be large and credible, and it had to happen in the moment. Paulson had to make the pronouncement then, and not wait for approval, and it had to be simple.

[UPDATE]: Here’s Megan McArdle with a great layman’s rundown of what was happening on Thursday.

Now consider the current situation on Monday morning. If “we” (i.e., the political leadership of the U.S.) go back on this commitment, then the loss of confidence will be even worse than it was last week. We are already trying to work around some of the inevitable inconsistencies that will be present in such an emergency action. As one example, consider that a federal guarantee for money market fund accounts means that they are suddenly much, much safer. Hence, Treasury has had to modify this guarantee over the weekend to apply only to pre-existing money market fund balances to prevent a massive flow of funds that could destabilize traditional commercial banks.

This is pure ad hoc economic management by government officials. It is a Hayekian nightmare on several levels, and as I said previously, its ideological consequences are likely to be substantial, long-lasting and negative. I can make the arguments as loudly as anyone, and I believe them, that the causes of this problem that can be laid at the feet of government are ill-advised market interventions and poor regulation, rather than insufficient controls on the market. The best long-term solutions, in my view, all involve less government intervention. It will be important to make these arguments. But the patient has been hit by a car, and is lying on the ground bleeding. It’s all well and good to discuss how irresponsible he was to wander drunk into the street, how we should better design our traffic control systems, and so on. But first we need to stabilize the patient and stop the blood loss.

It seems to me that the crucial prudential judgment to be made right now is this: How much time and freedom of action does the political process have to improve the bail-out before the time and/or complexity of the process serves to undermine the confidence-building impact of the bail-out? My view is, unfortunately, “not much”. We need to pick our battles, and focus more on trying to make the bail-out as flexible and temporary as practicable, than on trying to get a well-designed regulatory reform in the time and policy space available to us.