Moral of the Story

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The fate of the giant insurance company, American International Group, is a tale with a clear moral. Maurice “Hank” Greenberg built this company up from a storefront during a period of 40 years, turning it into the greatest insurer in the world, doing business successfully, and often as a pioneer, all over the world.

Elliot Spitzer, as New York State attorney general, said on television that he thought Mr. Greenberg had violated criminal statutes, which has never been alleged since, formally or otherwise. Mr. Spitzer threatened prosecution of AIG directors if they did not remove Mr. Greenberg as chairman — despite the fact he was the company’s controlling shareholder and founder.

Mr. Greenberg left, and now the State of New York, of which Mr. Spitzer was briefly the governor, and the Federal Reserve, have had to organize an $85-billion rescue package, for a company at which government meddling had already been instrumental in vaporizing $40 billion of shareholders’ money. Government took away, and has tried belatedly to give back. The moral: Best not to take away in the first place.

But this was just one error among many.

Broadly, the principal official financial policy errors in America during the last 15 years or so — during which time there has been minimal inflation and unemployment, and nearly 30 million net new jobs created — have been:

— Nothing has been done in American tax policy to discourage excessive debt accumulation by the American public, which has spent more than it has earned for years, most of it on non-durable goods, and much of it imported. This has created a terrible financial and psychological vulnerability almost throughout the population.

— Nothing has been done to reduce the back-breaking importation of oil, which has grossly raised energy costs, fueled inflation, enriched unfriendly states such as Russia, Iran, and Venezuela, and financed their mischief, and lumbered America with about half of its $800-billion annual current account deficit.

— Successive American administrations of both parties have sat, inert as suet puddings, while China has piled up a $265-billion annual trade surplus with America.

— The deliberate reduction in the value of American dollar came too late to save manufacturing jobs and went on too long for the good of the real buying power of American consumers. Meanwhile, Washington’s low-interest-rate policy was too deep and prolonged, and encouraged compulsive spending and expansion, and excess borrowing and speculation, especially in housing.

Beyond that, America and other countries have fallen too far into the fool’s paradise of the service economy. In all of the nearly 50 American metropolitan areas that have more than a million inhabitants, towering downtown skyscrapers are jammed with people who work hard and are very talented, but don’t actually do anything useful. People who make paper clips or rubber bands, or the proverbial widget, are at least producing something. But as a society, we came to despise blue-collar work as menial, and most of it has migrated to formerly Third World places. The service economy only works when people want and can pay for the services.

The merchant banks encourage deal-making, without regard to whether the deals make any sense for anyone except themselves, and do their best to incite compulsive corporate financial activity. They devise ever more complicated and risky financial instruments that — as with junk bonds, exotic derivatives, and securitized debt, including subprime mortgages — eventually get into difficulty. The merchant banks are paid for deal flow and transactional velocity, with the quality of debt and specialized equity being, until recently, an afterthought.

Now almost $400 billion, or half the U.S. Federal Reserve’s clear assets, have been committed to bailed out companies. For the first time ever, the federal government has issued debt to replenish the liquid assets of the U.S. central bank. Things can’t go on like this much longer, with a big bail-out and a big bankruptcy every week or two.

Except in the case of the most astute financial operators, capital markets tend to seesaw between euphoric insouciance and “nameless, unreasoning, unjustified, terror,” in Franklin D. Roosevelt’s phrase on the subject in 1933. It may be necessary to set up a special agency to exercise a trusteeship of troubled assets until they can be refloated, as the Reconstruction Finance Corporation did in the 1930s (when it was a large preferred shareholder of thousands of American banks), or the Resolution Trust Company in the 1980s, which cleaned up the savings-and-loan debacle.

Capitalism does carry the seeds of its own destruction. And odious though government intrusions often are, laissez-faire economics always brings the roof down eventually, as it did in 1929, on what the eminent writer Edmund Wilson rather acidulously called “the pretentious, gigantic, fraud.” That is certainly not being repeated now, but once capitalist zeal can operate in response to financial and imaginative temptation without any even arithmetical oversight, bad things happen, and there is no one but government to provide that oversight. Those who suffer most in these crunches are the victims of collateral damage: shareholders, clerical workers, and secondary people who serve the financial machine when it is running at high speed.

What is required is a three-step program to allay panic and fear; resurrect and strengthen prosperity; and provide long-term assurance against repetitions of the cycle that brought us to this point.

In the first step, the American government should raise spending (and bailing out financial institutions will ensure that), increase the money supply, cut the discount rate, and reduce taxes, and not with Senator Obama’s shell game of “refundable tax credits,” which is only one step short of the famous “voluntary tax” of the late Montreal mayor, Jean Drapeau.

The second step should unfold over the longer term, as America incentivizes savings, starts seriously to reduce energy imports, follows market forces in a redistribution of some effort from service to productive or research areas, and regains or exploits more of its sophisticated manufacturing potential.

The third step is creating the right combination of public-sector vigilance to prevent self-destructive financial excess, and private-sector fermentation, without regulators substituting themselves for commercially accomplished people.

Getting that right will, in turn, depend on the next American president. Both candidates were pretty unconvincing last week. But I still believe that a tax-cutting ex-combat pilot is a better bet than a soak-the-rich ex-social worker.

Conrad Black can be reached at © National Post

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