New Jersey Survival

The Republican Party was founded on big government and economic intervention with roots in the economic platforms of Federalist icon Alexander Hamilton and Whig leader Henry Clay. Indeed, the term “New Deal” was coined in 1865 to characterize Lincoln and his Republican Party economic platform. Republicans became the “mercantile” party of big business, big government, external protection, centralized monetary control, strong restrictions on immigration, and aggressive foreign policy.

From FDR’s New Deal to LBJ’s Great Society, Democratic policies forced many free-market activists into the Republican fold. People like Robert Taft, Barry Goldwater, Ronald Reagan, and of course Ron Paul, represent this free-market faction in the Republican Party. For example, free markets, deregulation, and balanced budgets became the Republican mantra (if not reality) during the Reagan administration. The orchestrated marginalization of Ron Paul is just one indicator that the free-market faction has been routed and that the mercantilists are firmly in control. In fact, as we endure the current economic malaise, we can note that the Republican-dominated Congress (1994–2006) and the administrations of George W. Bush have morphed Republican-style mercantilism into corporate socialism.

Harmful military spending, unbalanced budgets, fiscal irresponsibility, protectionist and monopoly handouts to friends is the old style Republican playbook. The new style is audacious, unprecedented, and truly awful for the economy. It begins with the Republican-controlled Federal Reserve, which, under Alan Greenspan and Ben Bernanke, has flooded the economy with money and credit and bailed out every economic crisis since 1987. Greenspan’s admonitions against “irrational exuberance” apparently were not intended to restrain the Federal Reserve’s irresponsible monetary policy. Who in their right mind could honestly say that the Fed had nothing to do with the housing bubble after driving the nominal interest rate to 1% and proclaiming that the mortgage market was well regulated?

But an insidious form of “market-based policy” is also a real culprit in the current mess. In 1999 a bill was passed by a Republican Congress and signed by Democratic President Bill Clinton that rescinded the Depression era’s divorce of commercial banking activities from investment banking, called the Glass-Stegall Act of 1933. That opened a floodgate of “creative” financial instruments backed by notes and other commercial paper. Much of the banking regulation of the Roosevelt administration — including abandonment of the gold standard — made absolutely no sense, but markets can fail with dire short-run consequences under a fiat monetary system. With Glass-Stegall, Congress put its finger on and mitigated the tendency and temptations of banks to create massive costly externalities to society, in this case, by holding bundled mortgage-backed securities which were deemed safe by rating agencies but which ultimately failed the market test.

The Financial Services Modernization Act of 1999 would make perfect sense in a world regulated by a gold standard, 100% reserve banking, and no FDIC deposit insurance; but in the world as it is, this “deregulation” amounts to corporate welfare for financial institutions and a moral hazard that will make taxpayers pay dearly. Such government privileges are nothing new to Republicans — consider the effective subsidies to the pharmaceutical, sugar, and steel industries — but this particular gift to financial institutions is what allowed the credit bubble to expand to such absurd proportions, because it allowed banks of all types to engage in increasingly risky transactions and to greatly expand the leverage of their balance sheets. As the crisis unfolds, credit continues to contract, the risk of bank failures increases, and the possibility of far more serious economic consequences become more apparent. The S&L crisis cost the taxpayers a few hundred billion, but this crisis has the potential of saddling the taxpayer with several trillion in bailouts.

So far, the Republican solution has been to bail out lenders — wealthy financial-industry professionals for the most part — who made unwise market decisions with subsidies and election-year subventions. With Hank Paulson, the former CEO of Goldman Saks, as Secretary of the Treasury and the big banks on the Board of Directors of the New York Fed, it should not be too surprising that the Fed has been listening only to Wall Street while ignoring Main Street.

The expansion of Federal Reserve authority is almost as alarming as nationalizing the mortgage industry. While the bailout includes the typical reductions in the Federal Funds Rate and the Discount Rate, it also includes the unprecedented moves to auction off discount rate loans, accept mortgage-backed securities in exchange for the Fed’s Treasury Notes and the financing of J.P. Morgan’s takeover of Bear Sterns. In May, the Fed began to allow investment firms to draw emergency loans directly from the central bank, and in July, it began to allow Fannie Mae and Freddie Mac to do the same even though such lending privileges had traditionally been restricted to commercial banks that have been subject to stricter regulatory supervision. All of this is predictable given the repeal of Glass-Stegall, which expanded the bad business practices that now “require” an expansion of the bailout.

But we see an even more insidious long-term economic problem, if that is imaginable. Moral hazard is endemic to this Bush-backed scheme to “relieve” an election-year economy. While the bill passed in late July does include some tighter regulation for the mortgage companies, it undeniably increases incentives for market participants — buyers and sellers — to engage in risky behavior. That is one of the products of financial socialism under a fiat monetary system — a system that mainly benefits wealthy lenders. Heads you win, tails you do not lose.