Fear Is the Economy’s Biggest Problem Right Now

Obama has followed Bush and Paulson's lead using fear to push bailouts and policies

The most cancerous aspect of the economic crisis today is not toxic debt, the credit crunch, or even the terribly misguided government bailouts. The most deadly challenge we face right now is fear.

As of this writing, the Dow is below 7,000. There is serious talk of nationalizing the banks. And Warren Buffett is telling the country our economy is in shambles. People understandably get scared facing such dread-but no one should panic.

Panics are never good and rarely warranted. It was the Panic of 1929 that sank the Depression-era banks. It was the post-9/11 panic that another terrorist attack was imminent that allowed the privacy-stripping Patriot Act to breeze through Congress. And it’s the apocalyptic language surrounding the current economic crisis that is contributing to our deepening recession.

At this point, the depth of the recession has largely been created by the panic started by former Treasury Secretary Henry Paulson and President George W. Bush. “If money isn’t loosened up, this sucker could go down,” President Bush said about the economy as he urged for bailouts last September.

Dire warnings of “catastrophe” or “before its too late” without any clear definition of what those concepts really mean are similar to, and no less troubling than, Mafioso scare tactics. It is this fear that has been driving the government to quick, impulsive action that is only worsening the problem.

Clearly fear and panic didn’t start the recession. There were system-wide failures due to a toxic combination of excessive growth optimism, a belief the boom would go on forever, a lack of healthy fear of losses, incompetency, and coercive regulations. But as Fidelity Investments executive Edward Johnson said this week, “We can only hope that the government’s cure doesn’t further sicken the patient.”

Looking back, most legislators regret passing their first cure – the Troubled Asset Relief Program (TARP) bill – as fast as they did. There wasn’t a clear and present danger at the time-just Secretary Paulson saying if we didn’t give him unlimited powers the sky would fall in and economy would collapse. No one understood what Paulson’s forecasts of catastrophe would result in, but they didn’t want to find out. Terrified, ‘doing nothing’ was not presented as an option and $700 billion was approved to buy up toxic debt.

Ironically, after a month of discussion the Treasury decided that buying troubled assets wouldn’t work after all and decided to go with capital injections instead. But this all took place many weeks after TARP was passed, and the world hadn’t ended. So much for the need for speed that was used to push the bailout through.

The same language has since been used, again and again, to push through the stimulus and other government actions. President Obama, officials and pundits keep saying that if we don’t act now it will be too late for America-but it is completely ambiguous as to what that warning means. Do banks that failed to protect their customers and investors go out of business? Do investors who bought houses in California or Las Vegas thinking they could flip the homes for big profits end up taking big losses on the properties? Does unemployment go from today’s 10 percent in California to 20 or 30 percent? What exactly happens?

The fear and panic has killed investor and consumer market confidence. And confidence is critical for economic stability. When fear sets in people stop consuming, they stop investing, banks stop lending, capital dries up, and growth subsides. America was already in a recession, yes, but the scare tactics of the Obama and Bush administrations have kept the market destabilized longer than it would have been.

“A failure to act, and act now, will turn crisis into a catastrophe and guarantee a longer recession, a less robust recovery, and a more uncertain future,” President Obama warned in February.

Pushing major policies on unfounded claims is not the way to govern, even during this steep economic downturn. Historical data offers us many avenues of action (and non-action) that we can consult to give us a good idea about the likely impacts of most fiscal policies.

The economy would not be in the shape it is now, with a Dow cut in half and banks sitting on their capital, if the recession had been allowed to clear misallocated resources, bad management, and general kinks in the market.

Lehman’s bankruptcy has actually created thousands of jobs as its assets are being liquidated in the market process. In contrast, bailed out AIG is just sucking down more tax dollars.

Letting AIG go bust, or letting Citigroup fail, surely would have hurt the market to a degree, but their stocks have plunged anyway. More than likely a few spectacular failures would have forced the banks to make the necessary choices to survive, however uncomfortable, and we would be experiencing some degree of stability today. Instead government’s activities have created a moral hazard issue as all firms are focused on positioning themselves according to what Uncle Sam says.

From Wall Street to Main Street, everyone is waiting for the government’s next move so it can act accordingly. Private equity is largely being hoarded because the market landscape is cluttered with bureaucrats. Why invest in any industry if the government might undermine you by bailing out a competitor or through nationalization? The fear of that is part of what is keeping credit frozen.

Unfortunately, Washington is not the only party guilty of unwarranted claims of doom. Libertarians and fiscal conservatives have frequently used words like communism and socialism when describing government activity to evoke images of the USSR satellite nations rusting into oblivion by their ultra-planned societies. Clearly the stimulus package will not turn America into East Germany. Nor will the trillions we’ve spent doom us to the Soviet fate without recourse. Capitalists, conservative pundits, libertarians, and the occasional Blue Dog should avoid the trap of apocalyptic propaganda messaging because it carries the same false, fear-mongering tone as the arguments we so harshly criticize.

That said, the White House and Congress need to change the way they are dealing with the financial crisis. Pushing costly taxpayer-funded bailouts in hopes of gaining a little bit of short-term stability is only propping up the problems. Market stability will not return unless investor and consumer confidence return. And confidence will not return until the fear subsides.

Anthony Randazzo is a policy analyst at Reason Foundation.