Green the Bailout

Many things make me weep about the current economic crisis, but none more than this brief economic history: In the 19th century, America had a railroad boom, bubble and bust. Some people made money; many lost money. But even when that bubble burst, it left America with an infrastructure of railroads that made transcontinental travel and shipping dramatically easier and cheaper.

The late 20th century saw an Internet boom, bubble and bust. Some people made money; many people lost money, but that dot-com bubble left us with an Internet highway system that helped Microsoft, I.B.M. and Google to spearhead the I.T. revolution.

The early 21st century saw a boom, bubble and now a bust around financial services. But I fear all it will leave behind are a bunch of empty Florida condos that never should have been built, used private jets that the wealthy can no longer afford and dead derivative contracts that no one can understand.

Worse, we borrowed the money for this bubble from China, and now we have to pay it back — with interest and without any lasting benefit.

Yes, this bailout is necessary. This is a credit crisis, and credit crises involve a breakdown in confidence that leads to no one lending to anyone. You don’t fool around with a credit crisis. You have to overwhelm it with capital. Unfortunately, some people who don’t deserve it will be rescued. But, more importantly, those who had nothing to do with it will be spared devastation. You have to save the system.

But that is not the point of this column. The point is, we don’t just need a bailout. We need a buildup. We need to get back to making stuff, based on real engineering not just financial engineering. We need to get back to a world where people are able to realize the American Dream — a house with a yard — because they have built something with their hands, not because they got a “liar loan” from an underregulated bank with no money down and nothing to pay for two years. The American Dream is an aspiration, not an entitlement.

When I need reminding of the real foundations of the American Dream, I talk to my Indian-American immigrant friends who have come here to start new companies — friends like K.R. Sridhar, the founder of Bloom Energy. He e-mailed me a pep talk in the midst of this financial crisis — a note about the difference between surviving and thriving.

“Infants and the elderly who are disabled obsess about survival,” said Sridhar. “As a nation, if we just focus on survival, the demise of our leadership is imminent. We are thrivers. Thrivers are constantly looking for new opportunities to seize and lead and be No. 1.” That is what America is about.

But we have lost focus on that. Our economy is like a car, added Sridhar, and the financial institutions are the transmission system that keeps the wheels turning and the car moving forward. Real production of goods that create absolute value and jobs, though, are the engine.

“I cannot help but ponder about how quickly we are ready to act on fixing the transmission, by pumping in almost one trillion dollars in a fortnight,” said Sridhar. “On the other hand, the engine, which is slowly dying, is not even getting an oil change or a tuneup with the same urgency, let alone a trillion dollars to get ourselves a new engine. Just imagine what a trillion-dollar investment would return to the economy, including the ‘transmission,’ if we committed at that level to green jobs and technologies.”

Indeed, when this bailout is over, we need the next president — this one is wasted — to launch an E.T., energy technology, revolution with the same urgency as this bailout. Otherwise, all we will have done is bought ourselves a respite, but not a future. The exciting thing about the energy technology revolution is that it spans the whole economy — from green-collar construction jobs to high-tech solar panel designing jobs. It could lift so many boats.

In a green economy, we would rely less on credit from foreigners “and more on creativity from Americans,” argued Van Jones, president of Green for All, and author of the forthcoming “The Green Collar Economy.” “It’s time to stop borrowing and start building. America’s No. 1 resource is not oil or mortgages. Our No. 1 resource is our people. Let’s put people back to work — retrofitting and repowering America. … You can’t base a national economy on credit cards. But you can base it on solar panels, wind turbines, smart biofuels and a massive program to weatherize every building and home in America.”

The Bush team says that if this bailout is done right, it should make the government money. Great. Let’s hope so, and let’s commit right now that any bailout profits will be invested in infrastructure — smart transmission grids or mass transit — for a green revolution. Let’s “green the bailout,” as Jones says, and help ensure that the American Dream doesn’t ever shrink back to just that — a dream.

A couple of months ago at lunch with a respected Fed watcher, I asked, “What are the odds are that US unemployment will reach 10% before the crisis is over?” “Zero,” he responded, in an admirable display of confidence. Watchers tending to internalise the outlook of the watched, I took this as reflecting opinion within the US central bank. We may have been in the throes of the most serious credit crisis since the Great Depression, but nothing resembling the Depression itself, when US unemployment topped out at 25%, was even remotely possible. The Fed and Treasury were on the case. US economic fundamentals were strong. Comparisons with the 1930s were overdrawn.

The events of the last week have shattered such complacency. The 3 month treasury yield has fallen to “virtual zero” for the first time since the flight to safety following the outbreak of World War II. The Ted Spread, the difference between borrowing for 3 months on the interbank market and holding three month treasuries, ballooned at one point to five full percentage points. Interbank lending is dead in its tracks. The entire US investment banking industry has been vaporised.

And we are in for more turbulence. The Paulson Plan, whatever its final form, will not bring this upheaval to an early end. The consequences are clearly spreading from Wall Street to Main Street. The recent performance of nonfinancial stocks indicates that investors are well aware of the fact.

So comparisons with the Great Depression, which have been of academic interest but little practical relevance, take on new salience. Which ones have content, and which are mainly useful for headline writers? 

First, the Fed now, like the Fed in the 1930s, is very much groping in the dark. Every financial crisis is different, and this one is no exception. It is hard to avoid concluding that the Fed erred disastrously when deciding that Lehman Bros. could safely be allowed to fail. It did not adequately understand the repercussions for other institutions of allowing a primary dealer to go under. It failed to fully appreciate the implications for AIG’s credit default swaps. It failed to understand that its own actions were bringing us to the brink of financial Armageddon.

If there is a defence, it has been offered Rick Mishkin, the former Fed governor, who has asserted that the current shock to the financial system is even more complex than that of the Great Depression. There is something to his point. In the 1930s the shock to the financial system came from the fall in the general price level by a third and the consequent collapse of economic activity. The solution was correspondingly straightforward. Stabilise the price level, as FDR did by pumping up the money supply, and it was possible to stabilise the economy, in turn righting the banking system.

Absorbing the shock is more difficult this time because it is internal to the financial system. Central to the problem are excessive leverage, opacity, and risk taking in the financial sector itself. There has been a housing-market collapse, but in contrast to the 1930s there has been no general collapse of prices and economic activity. Corporate defaults have remained relatively low, which has been a much-needed source of comfort to the financial system. But this also makes resolving the problem more difficult. Since there has been no collapse of prices and economic activity, we are not now going to be able to grow or inflate our way out of the crisis, as we did after 1933.

In addition, the progress of securitisation complicates the process of unravelling the current mess. In the 1930s the Federal Home Owners Loan Corporation bought individual mortgages to cleanse bank balance sheets and provide home owners with relief. This time the federal agency responsible for cleaning up the financial system will have to buy residential mortgage backed securities, collateralised debt obligations, and all manner of sliced, diced and repackaged paper. Strengthening bank balance sheets and providing homeowners with relief will be infinitely more complex. Achieving the transparency needed to restore confidence in the system will be immensely more difficult.

That said, we are not going to see 25% unemployment rates like those of the Great Depression. Then it took breathtaking negligence by the Fed, the Congress and the Hoover Administration to achieve them. This time the Fed will provide however much liquidity the economy needs. There will be no tax increases designed to balance the budget in the teeth of a downturn, like Hoover’s in 1930. Where last time it took the Congress three years to grasp the need to recapitalise the banking system and provide mortgage relief, this time it will take only perhaps half as long. Ben Bernanke, Hank Paulson and Barney Frank are all aware of that earlier history and anxious to avoid repeating it.  

And what the contraction of the financial services industry taketh, the expansion of exports can give back, what with the continuing growth of the BRICs, no analogue for which existed in the 1930s. The ongoing decline of the dollar will be the mechanism bringing about this reallocation of resources. But the US economy, notwithstanding the admirable flexibility of its labour markets, is not going to be able to move unemployed investment bankers onto industrial assembly lines overnight. I suspect that I am now less likely to be regarded as a lunatic when I ask whether unemployment could reach 10%.