First the good news. While the recession is getting worse,the financial crisis that started it has been containedfor now. The government has had to bail out only one big financial institution in the past six weeks.
The bad news is that the Bush administration and the Fed had nothing resembling a consistent strategy. They crushed Fannies and Freddies stock holders. They saved Citigroups. Ad-hockery is costly: it keeps private capital on the sidelines for fear of being wiped out in the next Sunday night rescue. And the government is now on the hook for perhaps trillions of dollars of guarantees and new capital,in return for which it got no extra power to protect the system and the taxpayer in the future.
What we need,and soon,is a resolution regime,governing how the government may take over any big financial institution and sell,nationalise or close it. We do have such a regime for deposit-taking banks,but its flawed in two respects. First,huge amounts of money are sloshing around outside the banks. Second,the biggest banks have long since become so thoroughly intertwined with the financial system that they cannot be neatly closed down as our laws once envisioned.
Designing such a regime is going to be a lot harder than just saying we need one. How are we going to decide which institutions are so important that they must come under it? And any institution we do agree to cover will be seen as too big to fail,obtaining an unfair advantage over its competitors in their cost of borrowing.
Whatever we come up with,voters have a right to be sure that we never get into this kind of mess again. The inability of the Republicans to forestall or fix the crisis was the main reason you won (after your charm and brains,naturally).
At a minimum,we will need much tighter federal oversight of the non-banks,and that is going to be hugely unpopular with Wall Street (though a bit of squealing from them is no bad thing for voters to hear). This ought to be part of a broader overhaul of a financial regulatory system that everyone knows is a mess: we have seven agencies overseeing banking,securities and futures and they still allowed the banks to behave like lunatics and failed to spot Bernie Madoffs Ponzi scheme. It took four years to pass the last overhaul. We dont have that much time: the crisis could claim its next victim at any moment. We have to figure out,right now,how we will respond.
© The Economist Newspaper Limited 2008