Tuesday, February 5 2013
Analysts often cite the dysfunctionality of the US political process and poor governance as reasons for pessimism about the long-term prospects for growth and the durability of strategic primacy in the twenty-first century. Certainly, political polarisation has inhibited the normal legislative process, delaying necessary reforms (eg, fiscal and immigration overhauls) and slowing recovery from the worst recession in 80 years. Yet, US policy and legislative responses during the most acute, dangerous phase of the financial crisis (2007-09) were among the most rapid, creative and effective in the world. Closer examination of these remedial measures provides necessary context when assessing the country's current political risk profile.
- Credit rating agencies will likely continue overstating US political risks -- which led to the loss of the US AAA rating in 2011.
- US responses to acute (as opposed to non-acute) strategic threats are usually rapid.
- Political polarisation will continue to slow fiscal and immigration reform, but is largely irrelevant to crisis response.
- Public attitudes to US crisis response policies, under both Bush and Obama, are likely to show continued improvement.
The immediate US policy response to the 2007-09 global financial crisis was fast, comprehensive and effective, particularly relative to other developed economies. It has left the country with a financial system that is promoting, rather than holding back, economic growth. Although political polarisation will continue to slow necessary medium-term policy reforms, Washington retains the capacity to respond with alacrity to acute economic or security crises.
While most of the policy measures adopted during the 2007-09 crisis were (at least initially) politically toxic that did not prevent the administrations of former President George Bush or President Barack Obama from acting. Indeed, their crisis response policies helped the United States recover more rapidly than any other G7 economy, except Canada, since the cyclical trough in 2009 (see UNITED STATES: Fiscal headwinds will not halt recovery - January 8, 2013). Arguably, they have also put it in a better position to grow going forward.
The most critical elements of the US response to the acute phase of the crisis were flexibility and comprehensiveness.
Flexible response: TARP implementation
The Bush administration's efforts to push the 700 billion dollar Troubled Asset Relief Program (TARP) through Congress in October 2008 had several false starts. However, once TARP was enacted, then-Treasury Secretary Henry Paulson decided to use the funds in ways not envisioned in the original legislation.
TARP, and most other crisis-response programmes, were major policy successes
The programme's primary intent was to purchase assets from banks directly. Paulson saw this as too complicated, given the difficulty of valuing impaired assets (eg, mortgage-backed securities) in the middle of a market panic. Indeed, there was some risk that the price paid by the Treasury would establish an extremely low price 'floor' -- forcing banks to revalue their assets at extremely low levels -- which might lead to further collapses after Lehman Brothers.
Reinterpreting the statute
Instead, Paulson decided to take direct equity stakes in the banks themselves via preferred stock, warrants and/or equity. This skirted the asset revaluation question while ensuring the largest banks had enough liquidity to survive. Moreover, it allowed the government (and taxpayers) to capture some financial upside when the market recovered.
Paulson's implementation of this plan, abetted by Federal Reserve Chairman Ben Bernanke and later his successor at Treasury, Tim Geithner, was even more remarkable. In essence, he was able to browbeat the leaders of the largest US banks into accepting forced recapitalisation -- partially via aggressive, meaningful stress tests. (The contrast with European stress tests, which had little impact on bank capital, is instructive.)
Initiating the auto bailout
Finally, Bush on December 19, 2008 used TARP authority to fund the first phase of the auto sector bailout -- though this involved a very 'creative' interpretation of the statute, which was supposedly limited to the financial sector.
In retrospect, this aggressive switch in TARP's aims and implementation was key to its success: according to the Treasury, as of December 31, 2012, it has recovered 405 billion dollars of the 418 billion dollars disbursed through TARP. This is 97% of the outlay -- and it may ultimately secure a gain on its total investment.
Comprehensiveness and scale
Also key to the effectiveness of the government's initial response was its comprehensiveness and overwhelming scale. Paulson believed it had to be huge enough (a 'big bazooka', as he termed it) to halt the negative real and psychological feedback loops that were producing market panic. Again, this effect was successfully achieved.
Indeed, by early 2009, the Treasury and the Fed had made available an enormous amount of potential funding (in addition to TARP), including:
- 800 billion dollars in liquidity support for money market funds;
- 600 billion dollars to support government-sponsored mortgage enterprises Fannie Mae, Freddie Mac and the Federal Home Loan Banks;
- an initial 200 billion (ultimately 1 trillion) dollars in Fed loans to support the issuance of asset backed securities (a market that was nearly frozen) through the Term Asset-Backed Securities Loan Facility (TALF).
- The Fed also extended credit lines to US subsidiaries of foreign banks during the most intense period of the crisis.
Thus, within months, Washington had effected Paulson's 'big bazooka', which allowed the financial industry to begin rapidly recovering by early 2009; US equity markets touched bottom at the same time, beginning a sustained rally.
Factors that facilitate US crisis response
US crisis response was also facilitated by several factors that, under different circumstances, are not necessarily conducive to good governance.
Deep understanding of markets
US policymakers exhibit a better understanding of market behaviour than their counterparts in many other countries
The main players involved, particularly Paulson -- a former CEO of Goldman Sachs -- had a deep understanding of how markets behave under crisis conditions, and thus why an overwhelming response was necessary (and might ultimately prove less costly down the road). While the 'revolving door' between government regulators and industry can lead to serious problems, such as 'regulatory capture', in this case it was of major assistance (see INTERNATIONAL: 'Revolving door' faces greater scrutiny - February 1, 2013).
The US system has always, by design, operated on two speeds: very slowly and deliberately during ordinary times, but very quickly during crises.
Paulson and Bernanke, and later Geithner and Bernanke, ensured that Treasury and Fed remedial measures and communications were mutually reinforcing.
In most cases, the regulators were able to stay ahead of, and frequently surprise, markets with the aggressiveness of their actions.
It is difficult to argue that the US government behaved dysfunctionally during the most acute phase of the 2007-09 crisis -- quite the contrary. Indeed, the persistent perception that the US system is 'broken' is attributable to the partisan gridlock that defines governance in normal circumstances -- not crisis conditions. This explains why analysts persistently overestimate US political risk: they conflate the ordinary operation of the US system (sclerotic and stalemated) with how it is likely to behave during periods of crisis.
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This article is drawn from the Oxford Analytica Daily Brief® which analyses the regional and global implications of key geopolitical, economic, social, business and industrial developments. It provides government, corporate and financial clients with timely, authoritative analysis every business day.