Chris Cox and the Financial Bailout

The Chairman of the SEC, Chris Cox, gave a speech last week on the need for the government to have an exit strategy in connection with its current spate of involvement in the market place.  The speech was given before a Joint Meeting of the Exchequer Club and Women in Housing and Finance in Washington, DC. Much of the speech has now been reproduced in an editorial at the WSJ.  The editorial has provided fresh impetus to offer some observations.

The topic is conceptually an interesting one.  As the US government invests increasing amounts into the private sector, the question of an exit strategy becomes very real.  Moreover, Chairman Cox has a unique perch from which to consider the issue.  This is true both because he is chair of one of the agencies at least tangentially involved in the current crisis but also because the SEC received an explicit role in TARP as part of the Oversight Board.  The Chairman is a member of the Financial Stability Oversight Board. 

With that in mind, his remarks are really not at all about an exit strategy.  Instead, its really a criticism of government involvement in the first instance.  Thus, he notes:

• But beyond that, beyond ideals of freedom, the national preference for private ownership is also based on the most basic practicality: it works. America's rise from New World outpost to global superpower was fueled by the dramatic growth of our free enterprise economy into the world's largest. Free enterprise has produced spectacular results. Compared to other national economies with substantial government ownership and central planning, America's economy has been more creative, resilient, and dynamic. We've found that decentralized decision-making, in which millions of independent economic actors make judgments using their own money, results in the wisest allocation of scarce resources across our complex society. And we've found the market to be more reliable in heeding price signals and meting out discipline to failing enterprises than government could ever be.

In other words, this is largely a paean to the market and opposition to government involvement in general.  Moreover, even accepting the value of the market to make the millions of economic decisions (as most do, including this Blog), the Chairman's approach only resonates if he can show that in fact government involvement has interfered with theis process.  Given that government involvement has been mostly in the form of loans and non-voting preferred stock, the bailouts so far have not involved any real interference in day to day management.  In other words, government involvement has not resulted in much interference with those millions of decisions.  In fact, that's one of the problems recently identified with Treasury's approach under TARP.  Huge capital infusions are being made without asking anything in return, including increases in lending. 

But the Chairman does identify some specific problems.  He notes that Treasury and the Fed have been involved in assorted acquisitions.  As he notes:

• On several occasions during the past year the Treasury and the Fed took on the unusual role of negotiators and principals in merger and acquisition transactions that normally would have been arranged by private parties. Even in these extraordinary cases, however, it remained the role of the SEC to regulate these transactions for the protection of investors. We took pains to stay at arms length in these cases, but our close collaboration with these same government agencies has made this truly terra incognita.

But this is an entirely different matter from capital infusions.  First, there is no reason to believe that Treasury and the Fed now view themselves as a necessary party to all acquisitions.  In other words, there is no need for an "exit" strategy.  Second, in the instances when these agencies were involves (the merger of Bear Stearns, for example), they had the safety and soundness of the financial system to consider.  Indeed, the non-involvement in Lehman and its ultimate failure probably acted as a catalyst for much of the current turmoil.  Said another way, Treasury and the Fed's failure is not involvement but an inadequate level of involvement.  Finally, while the number of transactions requiring Treasury/Fed attention is greater than in the past, this is a reflection of the magnitude of the current turmoil.  But in the past these agencies have always been involved in potential failures that could destabilize the financial markets.

He does make one effort to tie government involvement with capital infusions.  He counsels about the need to take great care in the handling of Fannie and Freddie Mac, both seized by the federal government. As he describes:

• The Federal Housing Finance Agency established the conservatorship for five stated reasons. First, both Fannie and Freddie were operating in an unsafe and unsound manner. Second, the current market conditions were deteriorating. Third, the financial performance at each company was poor. Fourth, the companies were unable to access the private capital markets for regulatory capital. Fifth and finally, they were critical to supporting the residential mortgage market in this country. But recent political pressures have added a new dimension. As the economic slowdown continues, and more homeowners risk losing their homes, it has become a political priority to reduce the number of foreclosures. Toward that goal, the government, as the functional owner of Fannie and Freddie, has committed both entities to ambitious plans to reduce foreclosure. The goal of reducing foreclosures, however, does not necessarily align with the goal of returning both entities to fiscal stability and solvency.

But Fannie and Freddie are in many ways unique, having started as government agencies that were only privatized to reduce government deficits in the 1960s.  Of course they deserve special consideration and of course they involve competing goals.  Their solution, however, will be unique reflecting their unique history.  They are not symptomatic of what's going on in the market or of a new found involvement by the government.

This is a topic that requires serious consideration.  But these discussions are less about the complexities of the issue and more about opposition to the policies of increased government involvement in the first instance.