Treasury Secretary Paulson leads us across the Rubicon

Summary:   The government’s solutions to our financial crisis is creeping nationalization, as becomes more obvious wth every new step.  This is history in the making, a major change in America.’s economic system — biggest since the New Deal — taking place with little public debate or consideration of the long-term effects.   That this happens during an election, without becoming an issue in the election, is an irony to be enjoyed by future historians.

Things are developing as I predicted in “A happy ending to the current economic recession” (12 February 2008).  Excerpt:

There are four ways we can unwind the excess debt of American households, ending the post-WWII debt supercycle.

1.  Growth:  given time and rapid wage growth, the debt burden becomes manageable.  We can pay it off ever more easily as incomes grow.  That was the dream solution to America’s high levels of household debt and large long-term government obligations.  It burst in 2000, and will not return in time to help us.

2.  Inflation, reducing the real weight of our debt.  This requires two things.  First, real growth in wages (no signs of this).  Second, either the cooperation or blindness of bond investors — they must either accept negative real after-tax yields, or remain oblivious to rising inflation.  The consequences are severe if our creditors (domestic and foreign) rebel.

3.  Defaults on loans, the equivalent of surgery without anesthesia — resulting in bankruptcies, homelessness, decaying neighborhoods, and bank failures.

4.  Socialization of the debt.  The government can spread the burden of debt in many different ways (that so many of our creditors are foreigners makes this even more attractive).

The US is already moving towards #4 through de facto nationalization of the banks, as loans by the Fed (and foreign governments) become the primary source of new capital. … A recession – especially if long and deep – will accelerate deterioration of both household and business balance sheets, forcing this nationalization process to continue.  The “Japan solution” is the course of least political resistance:  prop up the banks with lightly hidden government help and wait for natural forces to “heal” the economy over time.

There are many ways to socialize the debt.  The government (via the Fed or the Treasury) could expand its loans to banks in both size and duration, similar to what Japan did when they re-capitalized their banks with convertible preferred stock.  Or government-sponsored mortgage agencies could be the hidden hand providing support. 

Bringing this up to date

Since the deleveraging cycle started in December 2006 with the collapse of many mortgage brokers, the government’s response has been small incremental steps toward #4.  Now Secretary Paulson has taken the first large steps:

  • nationalizing the Government-sponsored Enterprises, and
  • announcing that the government will buy mortgage-backed securities (MBS).

The first was widely expected but still noteworthy, the government taking over the two key private financial institutions in the US.  This will not cost us anything — or so say the people who have been wrong about every step of this process.  It certainly puts us firmly on a road away from a free-market economic system.

The second was lost in the noise, but equally significant.  We — through our government — will borrow money (mostly from foreign central banks) to buy mortgage-backed securities (MBS).  We simultaneously will be debtor and creditor on the same loans, with others governments in the middle.  To illustrate the result, we collectively borrow from China 4% and lend to ourselves at 6%.  Nice, while it lasts.

Each step by the government is considered a big thing at that time — the various mortgage relief plans (“Project Hope”), the Q2 tax rebates, and now the nationalization of the GSE’s. All are just small steps in a larger process of unwinding the debt supercycle.

Something new in American history

Secretary Paulson has taken us across the Rubicon, as US public policy moves from the New Deal policy of macroeconomic stabilization (Main Street) to directly supporting the financial system (Wall Street).  While there have been isolated instances of this in the past, the scale of this move has no precedents since the Great Depression.  And in my opinion, few or no precedents including the Depression era.

Compare the costs and public benefits of this bailout with its Depression-era equivalent, the The Home Owners’ Loan Corporation (HOLC).  From Wikipedia:

A New Deal agency established in 1933 under President Franklin D. Roosevelt. Its purpose was to refinance homes to prevent foreclosure. It was used to extend loans from shorter loans to fully amortized, longer term loans (typically 20-25 years). Through its work it granted long term mortgages to over a million people facing the loss of their homes. The HOLC stopped lending circa 1935, once all the available capital had been spent. HOLC was only applicable to nonfarm homes, worth less than $20,000. HOLC also assisted mortgage lenders by refinancing problematic loans and increasing the institutions liquidity. When the HOLC ended its operations and liquidated assets, HOLC turned a small profit

What next?

Like each previous step, the government assures us that this will end the crisis.  Since the driver of the housing crisis is the above average rate of vacant housing units (4 -5 million surplus units), tinkering with the financial system probably will have little effect. 

I suspect that the economy will continue to slow, that more businesses will fail, and that this precedent (bailing out the GSE’s) will lead to more bailouts.  Once we have crossed the Rubicon, it will be difficult to change course.  There might be no shortage of likely candidates, such as

  • the automobile manufacturers
  • FDIC
  • the holders of credit card and auto loans
  • The pension benefit guarantee corporation (PBGC)

Who approved this?

Note the the important aspects of this decision, true of every step in this process so far.

(1)  Bipartisan, like most major policy initiatives in America.

(2)  An essentially discretionary act by the Executive branch, only vaguely authorized by Congress (with little deliberation).  Compare with the highly specific text of the Home Owner’s Refinancing Act which created the HOLC.

(3)  Weak or no basis for these actions in the Constitution.

That is how our government works today, with the Constitution just a fading dream.  Note how these momentous events have no role in the Presidential or Congressional campaigns. 

Where does this end?  Another excerpt from my February post

The US is already moving towards de facto nationalization of the banks, as loans by the Fed (and foreign governments) become the primary source of new capital.

… A recession – especially if long and deep – will accelerate deterioration of both households and businesses, forcing this nationalization process to continue.  The “Japan solution” is the course of least political resistance:  prop up the banks with lightly hidden government help and wait for natural forces to “heal” the economy over time.  For Japan this resulted in a period of slow growth which began in 1989 and continues to this day.

… Rescuing the financial system would not distract the Democratic Party {and perhaps the Republicans} from its major public policy goal:  nationalization of the health care sector (like that of other western nations).  Together these would represent a massive expansion in the scope of the US government, a repudiation of the post-1980 bias towards private-sector solutions. 

These steps are only the first phase in the end of the post-WWII economic and geopolitical regime. Looking beyond these takes us far into the unknown.

It’s all about choice.  Every downturn gives us the opportunity to determine what America will become.  We weigh our fidelity to our principles, our history, our forefathers — vs. our ability to collectively withstand pain (financial, social, political).  These are collective decisions, because all large-scale economic events have a decisive political component. 

We have an election in November.  Let’s make the candidates talk about these issues.  Act to make your voice heard by donating time and money to the candidates of your choice.

Please share your comments by posting below.  Please make them brief (250 words max), civil, and relevant to this post.  Or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).

Key Treasury Department documents

We cannot plead the “we didn’t know the details in the fine print” excuse. The important details about this massive nationalization have been clearly spelled out for us.  See this page for a current list of Treasury Department documents.

Some FM posts about the current crisis

For a full listing see the FM reference page about the Financial crisis – what’s happening? how will this end?.

A few of the most important posts warning about this crisis

This crisis has long been forecast by many, including in articles on this site.  Even now that we are in the whirlwind, these provide valuable background material on its causes — and speculation about the results.  Here are some of those posts.

  1. A brief note on the US Dollar. Is this like August 1914?, 8 November 2007 — How the current situation is as unstable financially as was Europe geopolitically in early 1914.
  2. The post-WWII geopolitical regime is dying. Chapter One, 21 November 2007 — Why the current geopolitical order is unstable, describing the policy choices that brought us here.
  3. We have been warned. Death of the post-WWII geopolitical regime, Chapter II, 28 November 2007 — A long list of the warnings we have ignored, from individual experts and major financial institutions (links included).
  4. Death of the post-WWII geopolitical regime, III – death by debt, 8 January 2008 – Origins of the long economic expansion from 1982 to 2006; why the down cycle will be so severe.
  5. Geopolitical implications of the current economic downturn, 24 January 2008, – How will this recession end?  With re-balancing of the global economy, so that the US goods and services are again competitive.  No more trade deficit, and we can pay out debts.
  6. A happy ending to the current economic recession, 12 February 2008 – The political actions which might end this downturn, and their long-term implications.
  7. What will America look like after this recession?, 18 March 208  — The recession might change so many things, from the distribution of wealth within the US to the ranking of global powers.
  8. The most important story in this week’s newspapers , 22 May 2008 — How solvent is the US government? They report the facts to us every year.
  9. The World’s biggest mess, 22 August 2008 — A brillant ex pat looks at America from across the ocean.

To see the all posts on this subject, go to the FM reference page about The End of the Post-WWII Geopolitical Regime.

16 thoughts on “Treasury Secretary Paulson leads us across the Rubicon

  1. FM: Surely our two parties are complicit in the largest expansion of the Leviathan’s federal powers in generations. For some time I believed President Bush’s legacy would be tied to the outcome in the Middle East. I was wrong; does this latest expansion not exceed FDR’s New Deal by some margin?

    Must rush off to re-read The Road to Serfdom.

  2. I know you are concentrating on the federal level, but the state of Minnesota has already offered much in the way of airline bailouts:

    Last month:
    * SUN Country airlines wants need assistance for the next two years from the Minneapolis Airports Commision (source)
    * A discount airlines wants aid, claiming to be the largest airline left in Minnesota after Northwest is purchased by Delta.
    * Here is an interesting document on the relationship of Minnesota to Northwest Airlines (ongoing loans, and unkept promises of jobs):

    I would put airlines at the top of the list. I suspect they will be permanently subsidized or nationalized (they can’t fail, or how will Congressman get home … not by Amtrak).

  3. It is a tenet of basic economics that if one wishes to perpetuate an economic behavior, there is no better way to do so than to subsidize it. What incentives are in place such that we have come to the place where we now find ourselves? Freddie Mac and Fannie Mae are only the latest in a long line of “businesses too big to be allowed to fail” that were taken over/bailed out by the federal government once their prospects dimmed. I recall the bailout of Chrysler well, not to mention the Savings and Loan scandal of the 1980s with Charles Keating, and finally the Junk Bond fiasco with Mike Millikin. Is it just me or do the miscreants responsible for these boondoggles always seem to escape more or less scot-free to some sun-drenched island with a mere slap on the wrist, while the taxpayer is left holding the bag? Oooppps, forgot one… Enron and Global Crossing. See what I mean? Some nice old lady down the street loses her life savings, and the bigshot gets a numbered acc’t in the Cayman Islands or Switzerland and a mansion in the Bahamas. Not that I think they’d taste too good, but I can understand wby some folk say “Eat the rich.” I won’t go that farm but let us at least punish them when they loot the treasury.

    Question: Isn’t it throwing good money after bad to rescue businesses that have been judged by the marketplace to be unfit for survival? And if we – the electorate – determine that some gov’t aid is necessary for struggling homeowners or rash loan-makers, isn’t it reasonable to expect in return some level of true, meaningful reform to prevent a recurrance of the problem? In free enterprise, business cycle failures serve to cleanse the system of inefficiency, promote accountability and shape behavior. By interrupting this feedback loop, we perpetuate the problem. Capitalism is a contact sport, and we all have to be willing to take our lumps when we make mistakes. By refusing to do so, we prevent corrective mechanisms in the market from operating. Ya gotta pay the piper sometime… and it will only hurt more when you procrastinate.

    Foolish me, here all this time I thought the free market was all about consequences… positive ones if you did your homework and placed sensible economic bets, negative ones if you wagered poorly. The current system of corporate welfare is basically “Tails I win, heads you lose.” If the high-rollers in these ventures make money, why then all is wonderful for private enterprise… isn’t life grand? But when things go badly, who goes running straightaway to the government – aka Joe Taxpayer – for a handout? The same people, of course.

    It seems to me that we have to get back to first principles in this country. That means…

    1. Building incentives into the system for responsible behavior. Should we be surprised when we reward reckless behavior – or at least minimize its risks – and then we get more of it? Our system is so slanted toward short-term profit at all costs that other equally-good or better values get crowded out, things like judgment, prudence, and restraint. Risk-taking has its place, but it is not the only value needed for a strong society and economy. As much of a cliche as it is, Grandma was indeed right; all things in moderation.

    2. Institute real punishment with teeth for white collar criminals that destroy the wealth of average Americans. We put a common bank robber behind bars for 20 years, for stealing a measly 40 or 50 grand, but allow white-colar criminals who take billions off with slaps of the wrist. Many of these sleazeballs get to keep much of their ill-gotten gains. By all means, punish the bank robber, but punish his slicker counterpart, who may wear a suit and use a pen instead of a gun, but is many times more destructive. What incentive does the corporate thief have to change his behavior, seeing his predecessors get off so lightly? In a word, none.

    3. The Founding Fathers recognized that freedom is not possible without risk. Making choices means living with the consequences of those decisions, even if they prove to be wrong. Moreover, leaders must experience the consequences of their choices firsthand; it is a recipe for corruption when those making decisions are shielded from the effects of their actions. We reward top-flight business leaders lavishly, with more wealth than any one person can spend. Is it so outrageous to want some accountability when these leaders fail us? How often have you heard of a CEO or other senior executive who gets a giant raise and/or a promotion when business is bad, while the rank-and-file get nothing, or even a pink slip? Corporate oversight in America is broken; members of the same “insiders” political class sit on eachother’s boards, rubber-stamp eachother’s raises and generally watch eachother’s backs, to the detriment of Joe Sixpack.
    We cannot allow the big dogs to take all the rewards when the system works, but pass off all the blame and cost when it fails. I am not sure of how to fix the system… but it cannot continue as is. Do any of you economic specialists out there have any ideas?

    Cynic that I am, I distrust any politician of either party who promises reform, yet sits on the same boards, buys the same investments and draws the same big checks as all the other insiders (Are you listening Mr. Obama?) or falls in with corrupt insiders like the Keating Five did (Mr. McCain, are you listening?). The truth of the matter is that the GOP and the Democrats are more like eachother than they are like average citizens, and they prove it by covering for eachother again and again. This year, the scandal is in the GOP, but next year it will be some Democrat… you cover me, and I’ll watch your back. That is how the game is played in DC. Maybe I’ll live long enough to see a true reformer one of these days; I hope so but I am not holding my breath.

  4. Ah “Corporate Socialism’ .. or a more technically accurate term .. ‘facism’. Nice of them to be honest at last. Note the last Govt that tried this (Mussolini) didn’t quite manage to make Italy an economic superpower. Now US taxpayers

    Now I have a rap for Keynes. Despite the bad and inaccurate propaganda he would have been horrified at this and would have worked himself into the grave trying to stop it happening.

    He was not a socialist, he was equally sceptical of Govt and business, he was a pragmatist, he believed in freedom, yes he was into monetary controls, he was anti booms and crashes (very much a steady growth man), he very much understood the need for hard currencies, yes he wanted Govt surpluses to balance times of market failures when deficits were needed (the cycle should balance). He was also a businessman, who made himself rich in the end and suffered many failures as well, so he had hard practical (sometimes very painful) experience.

    His entire post WW2 design was built to avoid this. Investment controls, bank controls, hard money (ie the US$ fixed to gold) at the core with only limited currency movement allowed by others, tax mixes that encouraged real investment (not the ponzi stuff we have all suffered through over the last 20 years), yes social systems, because they performed important economic roles (note the UK National Health system was built for very hard economic reasons, ie the difference in cost, with better health outcomes, compared to the US mess).

    As well he believed that increasing wealth was not an end in itself, but a means to a better life in all ways (health, intellect, arts, etc) and he was very suspicious about kleptocrats … those who crave money for money’s sake and who would do anything to get it .. including directly or indirectly stealing it.

    We all await another Keynes and we need him soon, because the last time this happened freedom disappeared all around the World.
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    Fabius Maximus replies: I agree, Keynes would have been horrified at the lax regulation that brought us to this point.

    However, on a deeper level this crisis results from limitations in Keynes’ theory (that’s not his “fault”, as every theory has limits). Aggregate debt levels in a society are not a significant variable in his theory. Debt has risen to become a limiting factor, and public policy experts — their vision bounded by Keynes paradigm — are surprised by this and uncertain how to respond.

    This is a classic Thomas Kuhn-type paradigm crisis. As OldSkeptic notes, we need a new economic paradigm — like Keynes provided to the Great Depression era — to light the way out.

  5. Corporate welfare is one of the things that never ceases to amaze me, and the hypocrisy of those same corporates when they demand government cuts to the average citizens rights or entitlements whilst attempting to secure a special status for themselves alone. Welfare of any sort needs to pared back to the bare minimum.

    There needs to be a community discourse on the role of government. There is no such discussion I fear in the main stream media. It is not something that has the attention that it deserves.

    Goverments seem to be about what you can’t do, as opposed to what you can. Through onerous laws and taxation the majority of the population are being involuntarily pigeon-holed … and without their realising it in most intstances. Their future creativity and choices, impaired due to a lack of fincancial freedom. Governments need to function more as an “enabler” so that their societies creativity can effervesce.

    Oppressive taxation and an aggressive cycle of debt I propose, is one of the main reasons the birth rates of western societies is on the decline. People today are postponing having children on the basis that they can not yet afford to have a child!

    This is not something that is unique in our time, as the Wikipedia article on Medieval Demography illustrates:

    by 1250, the population peaked and competition for resources meant that there was a great imbalance between property owners and workers. Rents went up, and wages sank; the unequal distribution of wealth increased between rich and poor. The conditions of the poor became so bad that they achieved net zero population growth.”

    You work six months of the year or more for the government (to pay your taxes) before you can even think of working to support yourself and responisibities.

    There are other moral questions at stake that have not been addressed with the take over of FHLMC and FNMA. It insulates individuals from the consequences of their own risk taking. Whilst it would no doubt be very painful, it is fun to speculate on what would happen if FHLMC and FNMA were just allowed to go under.

  6. & while all this is happenin’, the Rest of Us in The Free World are lookin’ forward to the next season of American Idol & Lost.

  7. With all the anti-Bush Dem politics — where is the Dem complaint about this takeover without enough discussion? Nowhere. (It’s too technical?) The rabid anti-Bush, anti-Iraq War focus of the Dems has made them a weak and inattentive opposition — oh wait, they control Congress now.

    They’re just not really interested in anything as much as excuses for more gov’t power.

    There is a new requirement to report the state of gov’t pensions more fully & completely (more honestly), but this has been opposed by many local cities.

    I do prefer more honest socialism, if the taxpayers have to pay for the mistakes in any case — I think there should be windfall taxes on prior ‘false’ bonuses, going back at least 7 years.

  8. I think FM noted this elsewhere: the purpose of the guarantee of Fannie and Freddie is to re-assure foreign holders of US debt, like Russia and China, so that they don’t further liquidate their holdings and thus force interest rates higher. Paulson’s action is not a case of corporate welfare, and certainly not a measure to protect American homeowners, but an unavoidable measure to protect the whole economy. Probably inadequate, too!
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    Fabius Maximus replies: While correct, that is not a complete decision. Like most of Secretary Paulson’s work, it is Wall Street-friendly. Such as leaving the equity and preferred stock holders with a stake in the company, instead of zeroing them out — as should be done in a public bailout.

    This Street-friendly approach puts us on the “Japan path”, instead of following the “tough love” methods of the S&L crisis. Remember that one of the reasons given why we would handle our crisis better than Japan was our superior accounting disclosures and willingness to close terminally sick financial institutions. When the pressure grew too great, the government abandoned these principles and has taken the easy road. Just as Japan did.

  9. FM said: “This is a classic Thomas Kuhn-type paradigm crisis. As OldSkeptic notes, we need a new economic paradigm — like Keynes provided to the Great Depression era — to light the way out.

    There is a difference between what should be done on the maro scale and what each and any one of us could do on the miro scale. The Greek philosopher, Diogenes can provide any one of us with a model. Most famous for his living in a barrel and his search for an honest man, Diogenes, the son of a banker, heralded as his philosophic quest, the debasement of the coinage:

    In his new home, Athens, Diogenes’ mission became the metaphorical adulterating/debasing of the “coinage” of custom. Custom, he alleged, was the false coin of human morality. Instead of being troubled by what is really evil, people make a big fuss over what is merely conventionally evil. This distinction between nature (“physis”) and custom (“nomos”) is a favorite theme of ancient Greek philosophy, and one that Plato takes up in The Republic, in the legend of the Ring of Gyges.

    Diogenes founded the Cynic (dog-like) school of philosophy. Many think that the classical cynic evolved into the Christian Holy Fool. Others note that it resembles the Daoist or Zen sage or the Hindu gymnosophist.

    In any event, it is a most timely response to the economic conditions FM describes. (Let’s face it, if the real estate crisis continues, a lot of us are going to be living in barrels anyway. )

  10. As a follow through to my prior post, there also is a Muslim variation on this them, the tales of Nasrudin.

    Much of Nasreddin’s actions can be described as illogical yet logical, rational yet irrational, bizarre yet normal, foolish yet sharp, and simple yet profound. What adds even further to his uniqueness is the way he gets across his messages in unconventional yet very effective methods in a profound simplicity.

    So far as Daoism is concerned, the Tao Te Ching is very well known; but also important is the book of Chaung Tzu.

    One of the founders of Taoism, Chuang Tzu was firmly opposed to Confucian values of order, control, and hierarchy, believing the perfect state to be one where primal, innate nature rules. Full of profundity as well as tricks, knaves, sages, jokers, unbelievably named people, and uptight Confucians, The Book of Chuang Tzu perceives the Tao—the Way of Nature—not as a term to be explained but as a path to walk. Radical and subversive, employing wit, humor, and shock tactics, The Book of Chuang Tzu offers an intriguing look deep into Chinese culture.

  11. I read “Gov. Palin as..” before I read this article and comments and thought I’d seen a change in discussion but WOW! To see this article and it’s responses gives me hope that some Americans are rediscovering free independant thinking. Long live the legacy of Franklin! Screw Adams , Hamilton, & Jefferson! Keep it up.

  12. A further comment: It is absolutely true he led us across the rubicon. And so is Sec. Gates. This is what Democracy is about. People worried about results leading toward necessary steps to seize the future for the country. Not the popular pablum that leads in the media. Or the political pablum that leads in campaigns. Great democratic leaders learn to ride the wave of wisdom that swells out of the people. Not the populist movement. These men have made wise but terrible decisions. And without most of the public or the media ever recognizing it. Or the politicians able to counter it. And they hold their offices due to the pressure of democratic processes. Their immediate predecessors held the same offices due to the preferrences of a dunce.
    We may regret Sec. Paulson’s move in the future. We may not. But we will certainly regret it less than inaction or false action motived by ideological stagnation.

  13. Re: comment #12
    Interesting. Paulson was not directly elected, which gives him greater freedom of action than someone who has to please the voters. But I do not see how much role democracy has in this. Are you saying that the indirect pressure from elected officials to place Paulson and/or Gates in their current positions is better at ensuring competence than a smart authoritarian giving the jobs to the right people? That democracy works best indirectly: the elected officials choosing (by consensus, more or less) proffesionals to do the actual work instead of doing it themselves?

    An interesting application of this principle would be to change the presidential election into an election of the electoral college who then choose (and possibly replace) the president at their discretion.
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    Fabius Maximus replies: Our system has elected officials. They appoint — with the advice and consent of the Senate — people technically qualified to run the Executive Branch. The appointees act without direct electoral check, another step in the delegation of power implicit in a representative democracy (a Republic). This combines acountability to the people with technical competence, balancing these two contradictory needs.

    I do not understand your point.

  14. Update — Some people questioned this from my post: “only vaguely authorized by Congress.”

    Evidence of this is already emerging, as Secretary of the Treasury Paulson attempts to fit his actions into the narrow opening created by Congress. Excerpt from Bloomberg article of 11 September 2008:

    “The federal takeover didn’t address whether the companies’ $5.2 trillion in debt should be included in the budget, or whether it carries an explicit government guarantee. In an interview this week with Bloomberg Television, Treasury Secretary Henry Paulson cited ‘incongruities’ in the law, saying ‘we should be clear, is there a government guarantee or isn’t there?’

    “… The stock purchase agreement is designed to discourage Congress from trying to change the terms of the agreement, the Treasury said. If Congress did try to change the law, it would open itself up to legal challenge, the fact sheet said.

    “‘As with any contract, the parties to the agreement may modify the covenants by mutual agreement only,’ the Treasury said.”

  15. Update: another voice heard from.

    We’re all capitalists now? Not any longer“, Anatole Kaletsky, The Times, 12 September 2008 — “An historic turning point has been reached: the West is ditching its faith in free markets and private enterprise.” Excerpt:

    Whatever happened to the triumph of global capitalism? Even more than “the end of history”, the idea that “we’re all capitalists now” became an article of faith around the world from the early 1990s onwards. In the past few years even the few holdouts – countries such as Libya, Cuba and North Korea – seemed on the point of acknowledging that markets, competition and private enterprise were the only rational way of organising economic life, regardless of politics or history or religion or national cultures.

    But just as the triumph appeared to be complete the innermost sanctum of the global capitalist system suddenly collapsed.

    The nationalisation last weekend of Fannie Mae and Freddie Mac, the two largest financial institutions the world has ever known, signalled the complete failure of the biggest, most dynamic, most innovative and competitive markets that have existed in the history of capitalism – the Wall Street stockmarket and the market for US bonds.

    Their failure has been so obvious, that even the most capitalist administration ever, in the world’s most capitalist country, had decided to wipe out the private owners of its biggest and most important financial companies and replace them with state-appointed bureaucrats.

    The reasons for these failures – related, ironically, to the dogmatic belief among regulators, politicians and financiers that “the market is always right” – have been much discussed. Much less widely considered have been the consequences of this justifiable disillusionment with market forces.

    … It is hard to imagine how squeezing private ownership out of the banking system could strengthen the cause of free enterprise and free markets. An early sign of which way the wind is blowing will come from a vote in Congress later this month on a request from General Motors and Ford for $25 billion in subsidised government loans to support their investment programmes through the energy and housing crunch. A few months ago such a request, which would, of course, be illegal under EU state aid rules, would have been unthinkable. Today, however, the question in Congress is not whether to grant this subsidy; it is whether to leave it at $25 billion or raise it $50 billion, as both Barack Obama and John McCain now propose.

    With banking systems around the world hobbled by the lack of private capital, the motor industry will not be the only supplicants demanding state support. There will be many more demands from industries, workers and consumers, as much in Britain and Europe as in the US.

    If the US loses faith with free markets, compromises the protection of property rights and hobbles its financial markets – all of which it has dramatically done in the past seven days – then Europe will surely follow suit. Emerging economies such as China and India will become even more ambivalent about market economics. Instead of We Are All Capitalists Now, There Are No Capitalists Left may become the ideology of the next decade.

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