By William Isaac, Published by Forbes
Repairing the economy is hard enough; restoring trust in government is even harder.
“Trust”–confidence in the honesty, reliability and fairness of people and things–is essential to democracy, a free market economy and the financial system. The breach of trust in recent years by our government and major financial institutions has been enormously damaging on many levels.
Mopping up the economic damage–a glut of foreclosed properties, millions of lost jobs, hundreds of billions of dollars of lost savings–will take time. Restoring trust between the government and the governed and between the captains of industry and the people who invest in their companies and buy their goods and services will be more challenging.
There were so many breakdowns leading up to the most recent economic crisis it is difficult to do more than enumerate some of the most important: reckless growth of Fannie Mae ( FNM – news – people ) and Freddie Mac ( FRE – news – people ) encouraged by government leaders; failure of the government to deal with the real estate bubble; excessive high-risk growth in major financial institutions; unwise and highly pro-cyclical regulatory and accounting policies; a politicized and fragmented financial regulatory system; rating agencies pursuing short-term profits at the expense of long-term excellence; and excessive borrowing and spending in the public and private sectors.
Once the crisis took hold, misguided actions by government leaders escalated what should have been a controllable situation into a full-blown crisis of confidence. With the Treasury at the helm, the government careened from one crisis to the next with inconsistent ad hoc solutions, which created the sense that no one was in charge with a coherent strategy.
Bear Stearns was bailed out through a government-financed shot-gun marriage to JPMorgan Chase ( JPM – news – people ), while Lehman was allowed to fall into bankruptcy. AIG ( AIG – news – people ), including its large bank creditors, was bailed out, while Fannie Mae and Freddie Mac were nationalized with common and preferred stockholders wiped out (including thousands of small banks that had been encouraged to invest in them). Washington Mutual was merged into JPMorgan Chase, but $20 billion of bond holders and $7 billion of fresh equity were wiped out.
The uncertainty was too much for the markets to bear. They could not determine which firms would topple next or how the government would handle the failures. Market participants lost faith in the government and in each other, causing banks around the world to stop lending–even to each other.
In late September 2008 the government we had trusted to protect us from panics itself panicked. Treasury threw together a plan (the “TARP”) to use taxpayer funds to purchase $700 billion of toxic assets from financial institutions. The plan was sold to Congress using highly inflammatory language (“financial Armageddon!”), which scared the public even more and deepened the economic downturn.
Treasury lost faith in its own plan and abandoned it almost immediately. Instead of purchasing toxic assets, it invested TARP funds in large financial institutions whether or not needed or wanted. To add insult to injury, Treasury also invested TARP funds in General Motors and Chrysler and their finance company arms, which was clearly not intended by Congress.
Government policy remains heavily focused on Wall Street and large institutions. The ill-considered, publicly announced “stress test” applied to the 19 largest TARP banks so rattled the markets that the government was forced to declare all 19 “too big to fail.” Yet to this day no one has designed a program to assist smaller banks in smaller communities, which are deemed “too small to save.”
The recently passed financial reform legislation adds to the widespread feeling that the system is rigged. The legislation does not address the major causes of the crisis, would not have prevented it from happening, and most certainly will not prevent the next crisis.
The fact that politicians are repeatedly making exaggerated and false claims about the legislation fuels the public’s cynicism. They say it ends too big to fail while leaving in place a dysfunctional regulatory system overseeing five major banks that control over half of the banking system and cannot be allowed to fail without causing economic chaos.
They brag about the new “watchdog”–the Systemic Risk Council–created to identify and control developing systemic risks. They fail to mention that the Council will be staffed and run by the very agencies–the Treasury, Federal Reserve, SEC and others–that led us into the crisis.
The damage to our institutions will be very difficult to repair. People have lost faith in the American dream: to get an education, work hard, save and invest, and build a better life for your children and their children. We trusted that the system would be fair and just for those who played by the rules.
I believe a critical first step in restoring trust in government is for voters to send a very strong message in November. Most of the individuals who brought us to the economic brink remain in place. We no longer trust them to be honest, competent and fair.
We need to elect people to Congress we can trust to put the government’s fiscal house in order and bring proper regulation to the financial sector, both of which are critical to getting the economy going again and restoring our faith in government and the American dream.
Original Article Located Here.