Voice

Why the political extremes might save the U.S. financial system

The Troubled Assets Relief Program expired yesterday. I've blogged about how this program was both cost-effective and a pretty significant policy achievement. This appears to be the expert assessment as well. The Wall Street Journal's Deborah Solomon and Naftali Bendavid explain:

It will ultimately cost far less than the initial $700 billion price tag that stunned a nation. Major banks are profitable and can raise capital. Credit spreads -- a key measurement of risk -- are down to pre-crisis levels.

The White House now projects TARP will lose at most $50 billion, down from $105 billion projected earlier this year. Privately, Treasury Department officials say the U.S. may not lose a dime, and could ultimately make money depending on how some investments fare, in particular American International Group Inc. and General Motors Corp. In a $14 trillion economy, $50 billion is less than 1% of economic output.

"The incredible irony here is that TARP probably succeeded wildly beyond anybody's imagination," said Alan Blinder, a Princeton University economist who co-authored a paper crediting the administration's economic policies with preventing a second Great Depression. "Suppose the original TARP bill had been to spend $50 billion to avert a catastrophe. Would anyone have blinked?"

Or consider the Financial Times story by Tom Braithwaite:

[A]ll of the consequences have to be judged against late 2008 and early 2009 when fear stalked the markets and nationalisation of the biggest US banks looked a possibility.

Making a play on a famous MasterCard commercial, Mr [Lee] Sachs outlines what the country got in return for its investments in the banks. “Dividends? Five per cent. Equity warrants? Two per cent. The economy not turning into the second Great Depression? Priceless.”

Despite this fact, however, TARP is ridiculously unpopular with the American people. 

Oddly enough, this might be a very good thing, for two reasons. First, the likelihood that the latest financial reform bill will prevent a future financial crisis is exactly nil. There will be moments down the road when the financial sector will come crying to Washington.   

TARP's biggest problem, however, was that it badly exacerbated the moral hazard problem. If banks know that they are insured against catastrophe, this gives them an incentive to act in a more risk-loving manner to maximize profits -- thereby increasing the probability of a catastrophe. While this might be a good thing in some sectors of the economy, finance is not one of them. 

TARP's political unpopularity, however, could help to eliminate the moral hazard problem. As Solomon and Bendavid observe: 

Perhaps the biggest fallout from TARP is that it precludes another TARP. Should the financial sector run into trouble, the chances of another government bailout are essentially nil. For many on Capitol Hill and beyond, the end of bailouts is a good thing. But some worry TARP's legacy could be a more devastating financial crisis down the road.

"The greatest consequence of the TARP may be that the government has lost some of its ability to respond to financial crises," concluded the Congressional Oversight Panel, which oversees TARP and has been one of its biggest critics.

Now, truth be told, I'm not sure this is entirely accurate. Sure, rescue packages are unpopular now -- but let the Dow Jones Industrial Average fall 800 points and politicians might react differently. If, however, the political perception is that no more bailouts from D.C. will be forthcoming, then it might condition financial players to act in a more prudential manner.

In other words, the Tea Party activists on the right and the netroots activists on the left might be the political lobbies that do the most to preserve the integrity of the U.S. financial system. 

I'll be spending the rest of the day savoring this irony. I welcome commenters trying to burst my cognitive bubble, however. 

Daniel W. Drezner

You say strengthening, I say weakening

Over at Shadow Government, Mary Habeck argues that al Qaeda's capabilities are on the rise, as evidenced by the recent effort to launch a trans-European Mumbai-style bombing. This is akin to a CNN headline I just saw: "Europe plot reveals al Qaeda adapting."

I would have assumed that these analyses  argue that recent events demonstrate al Qaeda's abilities to find ways to overcome current counter-terrorism tactics. 

But then I read the actual CNN story:

With al Qaeda struggling to replicate attacks on the scale of the devastation witnessed on September 11, 2001 in New York and Washington, security experts believe the Mumbai attack, which gained worldwide publicity, may provide the template for its future operations.

"This new plot is perhaps an indication that al Qaeda is trying to change its strategy," said CNN's Senior International Correspondent Nic Robertson. "The high-profile attacks that it has always liked using explosives are clearly getting harder and harder to perpetrate.

"The cells are being spotted and it's harder to keep undercover when you're making bombs. Even buying the material to make bombs is getting harder, so many analysts believe al Qaeda would be unable to mount a 9/11-style attack in the current climate.

"Therefore Mumbai would have been viewed as successful by the al Qaeda leadership as it killed a large number of people. This type of attack is just as deadly but harder to stop."

In the last year, a number of plots targeting the West have been foiled, including the failed Christmas Day bombing of a U.S. airliner; the failed car bomb attempt in New York City's Times Square and an alleged plan to attack shopping malls in Manchester, England over one holiday weekend in 2009.

This strikes me as defining adaptation down. Technically, events suggest that al Qaeda is adapting, which is a bad thing from the perspective of everyone preferring, you know, civilization. But the nut of this analysis is that al Qaeda's preferred tactics are being thwarted, and that they therefore have no choice but to switch tactics. This switch might lead to a greater likelihood of actual attacks, but their lethality seems lower. [But the CNN story suggests that this kind of attack is "just as deadly" as a 9/11-type attack?!- -ed. Yeah, that's wrong. The Mumbai attacks led to 173 deaths and 308 wounded.  These are appalling numbers, but they are not as appalling as the loss of life on 9/11].