But the truth is that Hayes was a strong and principled leader of firm character, who, during a critical time in history, shored up the country’s finances. His contributions to restoring American credit are worth noting today.

Hayes was a small-town Ohio lawyer until his Civil War exploits earned him a promotion to brigadier general and won him a congressional seat after the war. After one term in Congress, Hayes was elected three times as governor of Ohio. In 1876 he won the Republican nomination for president, and during the campaign that followed he defeated Governor Samuel Tilden of New York in a controversial election. Tilden won the popular vote, but Hayes won the electoral vote after a special commission awarded him the disputed states of Florida, South Carolina, and Louisiana.

Severe Inflation

Once in the White House, Hayes withdrew northern troops from the South and thus ended Reconstruction. But the enormous financial debts from the Civil War still lingered. That war had been so costly that the Union could not secure the cash (that is, specie) to fight it. Congress and President Lincoln covered expenses by issuing over $400 million in greenbacks, which would not be redeemable in gold until some future date. The flood of greenbacks caused inflation and chaos—merchants wanted specie, not paper that someday might be redeemed.

Many Americans, especially debtors who liked the idea of repaying loans in inflated currency, welcomed the greenbacks and wanted more to be printed. The problem with that, apart from serious inflation, was that foreigners were refusing to buy American debt, which raised the interest costs on the almost $2 billion that the Union borrowed to fight the war.

In 1875 Congress had promised to redeem the greenbacks for gold in four years and Hayes ran his campaign on a pledge to fulfill that promise. “Low rates of interest on the vast indebtedness we must carry for many years,” Hayes said, “is the important end to be kept in view.”

As president, therefore, Hayes prepared to retire the greenbacks. He had budget surpluses every year in office, and he used these extra funds to help build up a gold reserve to pay off the greenbacks. So effective was Hayes at this task that when the official government redemption date (January 2, 1879) came around, few people stepped forward to get gold for their greenbacks. Confidence in U.S. credit was such that most people traded greenbacks at face value with confidence that gold would be in the Treasury if they ever wanted it.

Having solved the greenback problem, Hayes also faced a crisis with silver. From the beginning of U.S. history, gold and silver coins (and bullion) had circulated to pay debts, to conduct trade, and to transact business. Silver of course is more plentiful than gold, and the ratio had been 15 or 16 ounces of silver to 1 ounce of gold. The U.S. Treasury in fact minted coins and traded the metals at 16 to 1 during much of the 1800s. But that all stopped after the Civil War.

The problem was that active mining in the American West was yielding much more silver than gold.

Also, the demand for silver was down because the rest of the world was beating a path to a monometallic gold standard. By the end of the 1800s, with silver prices down, it took about 32 ounces to buy one ounce of gold. The silver miners believed this devaluation of their metal was unfair. Those who favored inflation were happy to agree: If the government would stabilize the ratio at 16 to 1, debtors could repay in inflated silver dollars instead of gold. Flooding the market with silver (fixed at 16 to 1) would have the same effect as running greenbacks off the printing press.

Hayes was appalled at the persistent efforts of inflationists to tamper with the currency. “Expediency and justice both demand honest coinage,” Hayes insisted. Sound currency and sound character were one and the same to Hayes. “A currency worth less than it purports to be worth,” Hayes observed, “will in the end defraud not only creditors, but all who are engaged in legitimate business, and none more surely than those who are dependent on their daily labor for their daily bread.”

Free Silver

The inflationists lobbied hard with their politicians for what was called “free silver,” which was short for the free and unlimited coinage at the fixed ratio. They couldn’t muster the votes, but they did support the Bland-Allison Act in 1878.

Under that bill Congress would be obligated to buy at least $2 million (and up to $4 million) worth of silver and mint it into special dollars of almost one ounce. Such “dollars” in 1878 contained only about 90–92 cents worth of silver, and Hayes was dismayed that Congress would even consider tampering with U.S. coins that way. He promised to veto any “measure which stains our credit.” When Congress passed the act anyway, Hayes vetoed it. Congress, however, overrode Hayes with a two-thirds vote, and the Bland-Allison bill became law.

The presence of these new silver dollars bothered Hayes, but American credit remained strong throughout the world. The greenback problem was under control and the government continued to retire the Civil War debt through annual budget surpluses. In 1880, for example, federal revenue was $333.5 million, which was $65.9 million—almost 20 percent—more than expenses. The biggest item in the federal budget was $95.8 million for interest on the debt. With diligence, Hayes had renegotiated much of this debt from 6 to 5 and sometimes 4 percent.

In an effort to slash future expenses, Hayes began efforts to make government bureaucrats work more honestly and efficiently. In the New York Customs House, for example, some officials were extorting payments from importers and other officials were drawing salaries but doing almost no work. Since President Grant, Hayes’s predecessor, had suffered greatly from the shenanigans of dishonest government officials, Hayes tried extra hard to reform the civil service and make sure government graft was kept to a minimum.

Finally, Hayes showed balance in his administration. When, during a massive railroad strike in 1877, a state governor asked him to send in federal troops to preserve order, Hayes obliged. But he would not use federal troops to break the strike.

Hayes was a constitutional president. He believed in an executive strong enough to veto bad legislation, but he did not want to expand executive powers beyond what the Constitution specified. Congress was where laws needed to originate and where most political debate needed to take place.

Politics to Hayes was not a career. After serving one term as president, he happily stepped down and returned to private life.

Wright, curator for the Museum of American Finance and author of 11 books, has dedicated years of research to the lives and times of those individuals who bought, sold, and held the variable forms of U.S. debt issuances of the day. Tedious as that might sound, it’s actually fascinating. By recounting the trading of early U.S. government bonds, the author deepens the reader’s understanding of why people accepted the debt obligations of a new nation without a track record for repayment. In so doing, Wright destroys some myths, such as that only relatively wealthy Americans purchased the new debt securities, that the debt was just held domestically, and that debt securities were concentrated in only a few states and urban locales.

Wright sees a template for all successful economic growth in the evolution of U.S. dependability. He portrays it as a baseball infield where home plate is the government protection of life, liberty, and property. First base is the all-important financial system; second base is the entrepreneurial firm; and third base is the cadre of management expertise. The more solid each base becomes, the easier it is for the nation to rack up runs on the wealth scoreboard.

And so it is with debt. America entered a century of enviable growth in which federal bonds were regarded as outstanding investments. Thanks to Wright’s painstaking research, the midsection of the book fully illustrates the lives and times of bondholders.We learn about the people who held the debt and why they bought and sold it.We learn how debt issuances helped Revolutionary War veterans settle the frontier. We also learn how modern the new American financial markets quickly became. It wasn’t long before “flight to quality” had become an international stamp of approval for U.S. debt.

All told, Wright contends that U.S. national debt became a “national blessing” because we had a “non-predatory” government. The debt system was workable and credible because Washington had not become the all-consuming leviathan it grew into during the twentieth century.

Wright does include warnings aplenty, explaining why public debt, while serving as financial cement and trust among people and nations, is also to be feared. He quotes Adam Smith: “When national debts have once been accumulated to a certain degree, there is scarce . . . a single instance of their having been fairly and completely paid.”

Even Alexander Hamilton noted that there was a tipping point beyond which additions to the national debt would be deleterious: “Where this critical point is cannot be pronounced; but it is impossible to believe that there is not such a point.” Before leaving office as Treasury secretary in 1795, his final report on public credit sought to rectify “and to prevent that progressive accumulation of debt which must ultimately endanger all government.” The danger, though, is not to government, but to the people. When politicians can borrow and spend without restraint, people’s liberty and property are imperiled.

Some of the Founders knew that, and Wright adds gravitas to his book by contrasting the Federalists’ advocacy of a centralized financial system with the stance of the Antifederalists. One Antifederalist in particular, writing under the pen name Brutus, provided one of the most sagacious, prescient, and potent predictions in American history when he warned in 1788 that the federal government eventually would use the “necessary and proper” clause of the Constitution [last paragraph of Article 1, Section 8] to greatly extend its powers, thereby subverting state authority. We would have avoided many national disasters if people had heeded that warning.

Wright notes, “Unlike Adam Smith, Hamilton believed that the issuance of bonds by government augmented rather than destroyed capital.” Considering how much government in 21st-century America uses debt to finance astounding amounts of wasteful spending and the erosion of capital, I’d say Smith had the more realistic long-term vision.

One Nation Under Debt provides valuable history on the origin and development of U.S. fiscal affairs and warns us about where we are headed. The author looks on our national debt as a good idea gone awry, but I believe that the better view is that Hamilton’s debt system was a grave danger from the very beginning.

My discussion will focus on four distinct components of the 2008–09 stimulus: Federal Reserve policy, the Troubled Asset Relief Program (TARP), the Obama stimulus spending package, and the bailouts of automobile and financial firms. Because there is a temptation to stereotype political parties, labeling the Democrats the party of big government and the Republicans the party of limited government and fiscal conservatism, it is worth emphasizing that these policies were bipartisan. The Federal Reserve policies came during the Bush administration and under Fed Chairman Ben Bernanke, a Bush appointee. TARP was implemented by Bush and his Treasury Secretary Henry Paulson, and the bailouts of automobile and financial firms were initiated in the Bush administration.

My message is one of hope and change. The change is the four stimulus programs. The hope is this: I hope I am wrong about the permanent negative effects these programs will have on America.

Federal Reserve Policy

Two fundamental elements of Federal Reserve policy changed in 2008: The Fed began making loans to nonbank financial institutions and buying financial assets other than securities issued by the U.S. Treasury.

The Fed was established in 1913 primarily to lend money to member banks based on their assets that could be used to pay off the loans. Until 2008 the only firms the Fed would lend to were member commercial banks. Then the Fed began making loans to nonbank financial institutions. It did so to provide those firms with liquidity, but in doing so it broke with precedent in two ways. First, it made loans to firms that were not members of the Federal Reserve System, and second, it made loans based on questionable assets, running the risk that the borrowers might not be able to repay the loans.

The second major change was that the Fed bought financial assets not issued by the Treasury–so-called toxic assets held by private banks and other firms. The true value of the assets was questionable, so the Fed risked losses. The Fed can afford to take those losses, however. The biggest problem with this change in policy is that by buying some assets rather than others, the Fed was supporting some firms over others.

For example, it bought assets from AIG, an insurance company, to keep it from failing and ultimately has taken over ownership of AIG with an 80 percent equity interest. The Fed also purchased assets of questionable value from investment bank Bear Sterns to facilitate its acquisition by JPMorgan Chase. Meanwhile, investment bank Lehman Brothers went into bankruptcy and failed. Why save Bear Sterns but not Lehman Brothers? The Fed also initiated the Term Asset-Backed Securities Loan Facility (TALF) to make loans to holders of various types of securities. TALF borrowers do not have to be banks.

These two new policies are problematic because they constitute an “industrial policy.” I am not questioning the effects of these policies. Hindsight will provide a better answer. Rather, I am questioning the precedent that the policies create for future Fed involvement in the economy.

The Fed has now established the precedent of making loans to firms that, at its discretion, it deems worth supporting, based on assets of questionable value. That puts the Fed in the position of picking winners and losers in the economy. Similarly, by choosing to buy “toxic assets” only from some sellers it is supporting some investors while letting others fend for themselves. Again, the Fed is picking winners and losers.

Its conduct is much like what the Japanese government has done for decades. In the 1980s that government, coupled with Japanese banks, directed assets to the firms they viewed as most important to the economy. This industrial policy was hailed by many observers as giving the Japanese economy a growth advantage. In the early 1990s the booming Japanese real-estate market collapsed, much as the U.S. market did in 2006–08, and many Japanese banks were left holding assets of questionable value, collateralized with mortgages with higher face values than the mortgaged property. Rather than allow insolvent banks to fail, the Japanese propped them up, maintaining their precarious positions, and the Japanese economy has stagnated ever since.

Japanese industrial policy is no longer held in such high regard, but the Federal Reserve’s recent actions have it engaging in the same type of industrial policy. Having set that precedent, the long-run effects are likely to be pernicious. Unless the Fed firmly repudiates its industrial policy, clearly saying it made a mistake that won’t be repeated, financial firms will take the same risks, believing the Fed will step in to help if the market turns against them.

Many think that to avoid a repeat of the 2008 meltdown, the government should more tightly regulate the financial markets. President Obama has proposed a major overhaul of the regulatory apparatus.Yet financial firms are already among the most highly regulated firms in the nation, and it is implausible to think that the problems were the result of too little regulation. If anything, they were the effect of too much government involvement in those markets.

Market discipline is far superior to government regulation because firms that choose losing strategies will and should be allowed to fail. This would give every firm an incentive to choose profitable strategies and would weed out those that do not. The Fed’s industrial policy moves in the opposite direction, so more regulation would change nothing.

TARP

In September 2008 Bush Treasury Secretary Henry Paulson announced that the financial markets had frozen. Lending had ground to a halt, he said, and banks would not even lend to each other because their “toxic assets” called into question their solvency. Paulson asked Congress to pass emergency legislation providing him $700 billion to buy up those assets, creating liquidity in the financial sector so that normal lending activities could resume. TARP, approved on October 3, 2008, provided the money and gave the secretary the discretion to spend it as he saw fit.

Paulson claimed the money was needed immediately to prevent a collapse of the financial system. However, none of the TARP money went toward buying toxic assets. Instead the Treasury used the money to purchase equity interest in banks–that is, to partially nationalize many banks.

Paulson also pressured the nine largest banks to take the TARP money whether they needed it or not because if only some took the money, they would be stigmatized as weak, which could further undermine their financial positions. So now the federal government is the owner of a substantial share of the American banking industry.

Some of the strings attached to that money did not appear until after the government already bought into those banks. Obama and Treasury Secretary Timothy Geithner wanted to regulate the pay of bank executives, claiming that the federal government, as part-owner of those banks, should limit excessive pay. As a result, many recipients of TARP money are anxious to repay it and to buy back the stock the federal government now owns. But the federal government has put roadblocks in the way of banks that want to get out from under the burdens that come with TARP. The government likes that control. One fear that Geithner expressed is that if some banks escape the strings attached to TARP, they might raise executive pay, leading the better bank execs to leave the TARP-encumbered institutions for the higher pay at those banks that are free of TARP. (Some banks have started to pay the money back.)

The Obama Stimulus Package

Immediately after his election, Obama pushed hard to get Congress to pass a nearly $800 billion spending bill to stimulate the economy, which some claimed was mired in the worst recession since the Great Depression. While history will judge whether the recession was that severe, the rhetoric served to pass the bill. However, it is difficult to identify the features that make it a stimulus bill rather than just a big spending bill. In fact, the spending is largely for items Obama campaigned on. Much of it will occur after 2009 and so does not qualify as a stimulus for a depressed economy.

A lot of the alleged stimulus money was directed toward sectors that were holding up relatively well during the recession, such as healthcare and state and local governments. Government employment was steadier than private-sector employment when the bill was passed and can be expected to do even better with the money. Directing money toward relatively strong sectors is hardly the best way to stimulate the economy, even though it does further the goals that Obama campaigned on when he was running for president.

Even the economic analysis underlying the stimulus program can be called into question. The Keynesian idea is that by running budget deficits and increasing government spending, aggregate demand will be increased, pushing the economy toward prosperity. Of course, to spend that money, the government must first borrow it from elsewhere in the economy. There’s no free lunch. Moreover, if increasing government spending and running large budget deficits really led to prosperity, the economy would have been in nirvana by 2008. When Bush was elected in 2000 the federal budget was in surplus, and for Bush’s eight years government spending and the budget deficit continually increased, which by Keynesian logic should have produced a robust and maybe overheated economy, not an economy mired in recession. The Obama stimulus package was simply a continuation, on a much grander scale, of the eight years of Bush fiscal policy, a policy of continually increasing government spending and continually increasing budget deficits.

The Obama stimulus package was really just a big spending bill that did not offer much stimulus, but that will saddle the economy with bigger government from now on, hindering economic growth, slowing the recovery, and reducing prosperity

Bailouts

In addition to bailing out many failing banks and other financial firms, Bush and Obama also used taxpayer money to bail out Chrysler and General Motors. Bear in mind that when Obama campaigned for office and gasoline prices spiked above $4 a gallon, he advocated a windfall profits tax on oil companies. That idea fell by the wayside as prices fell in 2009, but these two policies provide a chilling example of how to undermine the very foundation of the market: When companies are successful and profitable–like oil companies in 2008–single them out for extra taxes, and when companies are unsuccessful and unprofitable–like auto companies in 2009–single them out for government subsidies.

One need understand only the most basic of economic principles to see how pernicious these policies are. If firms in an economy can take resources and combine them into products that are more valuable than the resources they started with, they are adding value to the economy and should be rewarded. In a market economy they are–through profits. If firms take resources and combine them into products that are less valuable than the resources they started with, they are harming the economy and they should be penalized. In a market economy they are–through losses. Profit and loss are essential to the operation of a market economy and provide the signals and incentives that have led to the remarkable economic progress that has characterized America (hampered as the economy is by government).

The bailouts began as loans to Chrysler and General Motors, which the firms had no chance of being able to pay back. The administration’s way of addressing this has been to negotiate to convert those loans into an equity interest in the firms, thus nationalizing the automobile companies in a manner similar to how TARP has nationalized banks. The federal government carries a big stick and is in a position to use that stick to its advantage. Under Obama’s bankruptcy plan for General Motors, the government will control 60.8 percent of the company, with 17.5 percent for a United Auto Workers trust fund. Bondholders could wind up with a 10 percent equity interest in the company.

On the surface this appears quite unfair to bond holders, whose bonds had a face value of $27 billion. Some bondholders objected, rightly saying that the claims of holders of secured debt should come before the claims of the firm’s employees in any bankruptcy proceeding. But while some bondholders objected, many did not–because they were recipients of TARP money and therefore effectively under government control. TARP recipients JPMorgan Chase, Citigroup, Morgan Stanley, and Goldman Sachs owned about 70 percent of Chrysler’s debt. The government supported them with bailout money and then bullied them to give up their assets to the UAW.

The pernicious consequences go well beyond these transactions. How will this affect other union-heavy companies when they try to raise money in the bond market? The precedent is set for employees to move ahead of secured-debt holders in bankruptcy proceedings. Debt finance will become much more difficult for firms with unionized labor forces. One critic argued that the favoring of the UAW over bondholders amounted to shaking down lenders for the benefit of Obama’s political supporters, which is corruption and abuse of power. We would have done better to let the market and the bankruptcy court determine the fate of Chrysler and GM.

Fundamental Transformation

When we step back and look at the bipartisan efforts to rescue the economy from recession, those changes represent a fundamental transformation in the nature of the American economy. In the longer run Obama wants to substantially increase government’s role in health care, which is already largely in government’s hands with Medicare, Medicaid, SCHIP (health insurance for children), and the regulations that govern healthcare providers and pharmaceutical companies. Obama has also stated his intention to further regulate the energy industry to limit emissions and to shift production toward renewable energy sources. His cap-and-trade initiative would impose billions in costs on the economy and would effectively dictate the technologies by which energy is produced.

Few commentators are looking at the long-run implications of these changes, focusing instead on how much the proposed Obama deficits will increase the national debt or on how the Federal Reserve’s increases in the monetary base will impact inflation in coming years.

Déjà Vu All Over Again

I have described the changes. My hope is that I am overestimating their long-run impact. Indeed, the nation has found itself in similar situations before. In the 1970s we faced economic stagnation, rising unemployment, and rising inflation, which soared into the double digits. There were government-mandated price controls and frequent lines at the gas pumps as a result of shortages caused by those price controls. There was every reason to be pessimistic, but in the 1980s the Reagan administration turned many of those things around. Tax rates were slashed; the price controls were abandoned; and a more deregulated  economy led to two decades of growth and prosperity. At least some of the credit for this, as well as much of what happened in Margaret Thatcher’s England, must be attributed to the power of ideas emanating from Milton Friedman and other free-market thinkers.

Similarly, in the 1940s socialism seemed such an attractive alternative to American capitalism that F. A. Hayek wrote The Road to Serfdom, arguing that socialism was that road, and Joseph Schumpeter, in Capitalism, Socialism, and Democracy, lamented that in democracies people could vote away their freedoms and that the people who benefited the most from a free economy were unwilling to defend it. Yet America prospered. When the Berlin Wall collapsed in 1989, followed by the demise of the Soviet Union in 1991, there was every indication that everyone would recognize that market allocation of resources is better for everyone than government planning.

Now we stand, two decades later, on the brink of the most significant erosion of the market economy since the New Deal, with relatively few dissenters. In a few short centuries markets have taken much of the world’s population from subsistence to remarkable prosperity and continuing economic progress. Are we really ready to abandon that system and replace it with something similar to what resulted in the collapse of the Soviet Union?

Things have gotten so bad that no dissention can be tolerated. The German Chancellor Angela Merkel was harshly criticized for not going along, at least to the requisite degree, with the stimulus consensus. She stood out as “Frau Nein” until she went along with a “moderate” package.

I am not a macroeconomist. I am not even a financial economist. So much of my reaction to the current financial and economic problem may seem out of step with what most commentators are saying. Yet I think it is important.

Collective Irrationality

The macroeconomic frame of mind is quite peculiar. In the name of the emergency, this way of thinking dismisses most concerns about the efficient allocation of resources and throws almost total emphasis on maintaining levels of expenditure and employment. The implicit assumption is that the central problem is a collective irrationality that inhibits people from spending on consumption or investment. The root of the central problem, conceived in this way, is the initial financial meltdown. This involved a kind of domino effect in which the collapse of the housing market and of mortgage-backed securities, packaged in many complex ways, undermined the liquidity and even solvency of many financial institutions. The system’s ability to provide credit and thus expenditure was compromised, although at this writing the reduction in bank credit available has been relatively small.

Thus the solution, we are told, lies in returning to the status quo ante. Restore the condition of the financial institutions—perhaps by buying toxic assets or perhaps by infusing capital into the institutions. Restore the conditions of the housing market by getting the Fed and/or Treasury to buy Fannie and Freddie mortgage securities, thus sending capital into housing and lowering mortgage rates. Restore the condition of industries with large numbers of employees and others indirectly dependent on them. (So far, the automobile industry qualifies.) In general, restore the pattern of expenditure that prevailed before the crisis.

I realize that no economist believes that complete restoration to the previous situation is possible, but the basic philosophy is clear. Once economic agents believe something like this will take place, confidence will be restored.

The critical issue is this: Has the current situation—triggered by unsustainable levels of mortgage credit and production in the housing industry as well as in other interest-rate-sensitive areas—gone so far beyond its cause that we no longer need to worry about these previous misallocations of capital? In other words, is the correction of the cause now irrelevant to the cure?

Stimulus ex Machina

To discover the answer to this question, let’s step back a bit. We must understand the respective roles of causes and feedback effects. This is the “Keynesian” argument. Suppose a fall or collapse in markets X, Y, and Z causes F (a financial meltdown). Then F itself causes X, Y, and Z to fall further. Some of this is deleveraging, and some is the result of falling confidence in, say, the creditworthiness of counterparties. There is a general lack of clarity about what resources and financial instruments are worth. The future begins to look radically uncertain rather than simply risky. A collapse of confidence thus contributes to a fall in production and employment in areas far removed from the initial bubble-burst. The process is not dampening but explosive in the absence of the deus ex machina—that is, fiscal or monetary intervention.

Now let us imagine a cure that ignores the original misdirection of resources to the degree that it treats the collapse in these markets as mainly due to some exogenous loss of confidence. The Federal Reserve decides, as it actually has, to buy mortgage-backed securities, causing credit to become available in the housing market at lower interest rates. This also causes the prices of homes to stop falling and to begin rising. When will the Fed stop this infusion of newly created money, and hence a relative rise in resources, into the housing market? Presumably it should stop when the sector is brought back to a level that is simply a correction of the previous excess. In other words, the Fed should prevent the additional, “irrational” decline due to “feedback” effects.

Where is the feedback-sanitized point? I doubt anyone knows. Consider what it means to know. The planners would have to know the array of housing prices corresponding to the normal fundamentals of the housing market. This would be the prices that prevailed when the market was not overexpanded. However, it would not correspond simply to the average of recent values because the housing market has been overexpanded for so long. Recently, two economists have attempted to estimate these prices. (“First, Let’s Stabilize Home Prices,” by R. Glenn Hubbard and Chris Mayer, Wall Street Journal, Oct. 2, 2008.) Unfortunately their attempt is marred by the same extrapolation of historical experience that seems to have gone terribly wrong in the assessment of the risk associated with derivatives and mortgage-backed securities. More importantly, however, it seeks to determine normal market prices in the absence of a freely functioning market.

Suppose, however, the Fed is realistic and admits it doesn’t know. It will then simply try to get the housing market (and other similar interest-sensitive markets) to such a point where general production and employment are considered non-recessionary. The standard, practically speaking, will be the status quo ante. This is because of the lack of theoretical-empirical guidance discussed above and because the various sectors, bolstered by various politically powerful pressure groups, will not be satisfied until they are made whole. At this stage we would be left with the unsustainable direction of resources more or less back in place. The direction is unsustainable because, as the original bubble revealed, it was not consistent with the preferences of consumer-saver-investors.

Why it Won’t Work

Therefore the conventional macroeconomic diagnosis and proposed cures ignore many important structural or microeconomic factors, including the following:

1. The “irrationality” is not primarily in the system’s response to the initial financial impulse but in the unsustainable expansion of the housing and other capital markets in the first place. Proposals to prop up the housing market as if its contraction is some kind of unfortunate overreaction are not credible. Too many resources went into the housing market due to the low-interest-rate policy the Fed followed for too long. While housing prices have fallen recently in many markets, they need to fall further. Markets should be allowed to equilibrate.

2. Equilibrium in the housing market would provide greater transparency to the value of mortgage-backed securities. Lack of certainty about housing prices and the ultimate extent of foreclosures only adds to the problems surrounding the illiquidity of these securities.

3. Government infusion of capital with the purpose of restoring the status quo ante ignores the facts: Fannie and Freddie were overexpanded, the domestic automobile industry is a destroyer of scarce capital, some financial firms did a poor job of allocating risk, banks extended loans under the pressure of the government to people who should not own homes, and so forth. Resources were misallocated.

Confidence Follows Correction

Recessions are not simply crises of confidence or of insufficient demand (due to increases in the demand to hold money). They also have their allocational—or microeconomic—aspects. I suggest that these systemic distortions have an important role in creating the aggregate phenomena we are witnessing. To treat these distortions and their cure as relatively unimportant is a mistake. Lasting investor and consumer confidence follows the correction of the underlying causative distortions and does not precede them. In fact, the dominant macroeconomic policy framework does not leave room for correcting distortions at all because its basic theme is to restore, prop up, and maintain the current direction of resources.

The hastily approved macroeconomic schemes of the Bush and Obama administrations will not succeed in promoting lasting recovery because they ignore the microeconomic fundamentals. The direction of spending and hence resource allocation they generate are fragile—they are not consistent with the preferences of consumers, savers, and investors. Therefore, once the putatively temporary stimulus is complete, the corrective forces that are now trying to undo previous resource misallocations will reassert themselves.

In the longer term, the threat of significant inflation looms large. After the U.S. Treasury has incurred the additional trillions of dollars in national debt (at least one trillion in George W. Bush’s response to the crisis and a minimum of one more in Obama’s response) and the Federal Reserve has completed expanding its balance sheet (thus creating new money) by some trillion or more, what will happen? Will the federal government abolish the stimulus programs, raise taxes to pay off the increases in the national debt (or even to service the debt), and cut entitlement programs? The constituencies that will be formed by the stimulus spending will resist. Will the Fed begin a contractionary monetary policy to absorb all the excess money it created in the name of the emergency? That would raise interest rates and the cost of servicing the huge national debt. What is probable is that we will see an effective repudiation of part of the national debt through inflation. The temptation will be all but irresistible to inflate ourselves out of this mess. The economic consequences of the “cure” will be worse than the disease.

Just one day later, September 20, the Bush administration announced a price tag: It would ask Congress for what the Times described as “unfettered authority for the Treasury Department to buy up to $700 billion in distressed mortgage-related assets from the private firms.” News reports noted that $700 billion amounts to more than $2,000 for every man, woman, and child in the United States. Secretary Paulson released a three-page draft of the legislation he wanted. It did not specify how the money would be spent, but did say that no court could review the Treasury’s decisions about spending the money. Paulson warned of dire consequences should Congress not approve the legislation quickly and as proposed.

In asking for huge sums and unrestrained power for government to intervene in financial markets, Bernanke and Paulson discarded any pretense of adhering to free-market principles. The Times reported that an attendee at a strategy meeting quoted Bernanke as justifying the abandonment of principles by declaring that, “There are no atheists in foxholes and no ideologues in financial crises.” The aim of avoiding a deeper crisis, in other words, rationalizes whatever seems expedient. We should flee from the threat of a “financial meltdown” even into the arms of a constitutional meltdown. Surprisingly, many “free-market” commentators and economists echoed this sentiment. Some of them pledged to reaffirm free-market principles in the future even while calling for their abandonment for the duration of the financial turmoil. Their questionable judgment seems to have been that more government intervention was needed to offset—and would offset rather than compound—the previous interventions that had created financial chaos.

Few in Congress questioned the figure of $700 billion. Some House Republicans proposed a nominally less-interventionist plan that would have had the federal government not purchase—“only” guarantee—home-mortgage assets. Instead of putting an explicit price tag on the taxpayers’ burden for the bailout, government guarantees of mortgages and mortgage-backed securities would have obliged taxpayers to pay lenders and bond holders whenever and wherever borrowers or security issuers defaulted, implying off-balance-sheet taxpayer exposure on an unspecified scale. A blank check rather than a $700 billion check—some improvement.

After congressional wrangling for nine days over what to add to the three-page Treasury proposal, a bill of 110 pages emerged. A deal had been struck. The Treasury’s authority to purchase had grown beyond mortgage-related assets to include “any other financial instrument that the Secretary, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, determines the purchase of which is necessary to promote financial market stability.” In other words, whatever the two wanted.

Shock in the House

On Monday, September 29, the House of Representatives shocked political pundits by voting down the bailout bill 228–205. With constituent email and phone messages to Congress running heavily against the bailout (some estimates said 30–1), the majority that day disregarded dire warnings that Congress had “no time” to put any more careful thought into what it was doing.

Two days later, however, the U.S. Senate approved a further-revised bailout bill 74–25. Although they had not taken time to put a lot of additional thought into it, senators had nonetheless added a lot of text: The bill had now grown to 422 pages. The Emergency Economic Stabilization Act of 2008 now not only provided $700 billion for a Troubled Assets Relief Program, but also included sections and subsections on Renewable Energy Incentives, Carbon Mitigation and Coal Provisions, Transportation and Domestic Fuel Security Provisions, a grab-bag of tax-credit extensions, a subtitle for Mental Health Parity and Addiction Equity, another for Heartland and Hurricane Ike Disaster Relief, an increase in federal deposit insurance, and authority for securities regulators to relax accounting rules that financial firms facing mortgage-related losses were finding inconvenient. The height of special-interest absurdity was reached in Section 503 of the Act which, according to the official Library of Congress summary, “Exempts from the excise tax on bows and arrows certain shafts consisting of all natural wood that, after assembly, measure 5/16 of an inch or less in diameter and that are not suitable for use with bows that would otherwise be subject to such tax (having a peak draw weight of 30 pounds or more).”

Two days after the Senate vote, on Friday, October 3, the once-reluctant House approved the bailout bill 263–171. In the second House vote 33 Democrats and 25 Republicans switched from no to yes. One congresswoman unashamedly explained to National Public Radio that she had switched because the new bill included solar-energy tax credits. President Bush immediately signed the bill. Prices on the New York Stock Exchange, which had closed way down the day the first bill had failed to pass, closed down again on the day the revised bill passed and was signed into law.

“Plan” A

The “plan” for how to spend the $700 billion bailout has always been extremely vague, from its inception in the Bernanke-Paulson phone call, through the case Paulson made before Congress, to the passage of the enabling legislation. Improvisation continued up to the date this account was written in late November. The Treasury originally announced an intention to buy troubled mortgage-related assets, and hence the bill refers to a Troubled Asset Relief Program, or TARP. But on what terms would they buy these assets? More than a month after passage, that had yet to be made clear. American Public Media’s Marketplace program reported on November 7 that, “A securities industry trade group just came out with a survey, and it found that financial players are so unclear about how TARP would work, they aren’t sure they want to participate.” The Treasury had to schedule a meeting with banking industry representatives on November 10 to fill them in on the evolving specifics of TARP.

The “troubled” assets to be purchased are mortgage loans, bundles of such loans (“mortgage-backed securities”), and apparently any other financial assets the Treasury wants to include. What makes them “troubled” is basically that financial institutions can’t sell them for what they paid for them. The basic reason is that an unexpectedly huge share of mortgages has gone bad: Mortgage-default rates have skyrocketed. Further, the secondary market for mortgage-backed securities has dried up. A firm trying to sell some of its holdings would fetch only fire-sale prices.

There is a basic problem with having the Treasury buy assets that the market won’t buy except at fire-sale prices. Either the Treasury outbids the market and overpays for the assets—which benefits financial institutions at taxpayer expense—or the government pays the current market price, which would compel banks to mark other assets down accordingly and book the losses they’ve been trying to avoid booking.

In arguing for the bailout, Bernanke proposed that an “auction” of troubled assets for taxpayer-provided dollars would enable accurate “price discovery,” even though the Treasury would be the only bidder, and thereby would restore an active market. How such an auction would work, how it could be designed to arrive at hoped-for prices—above current market prices but not above what the assets would supposedly be worth in a normal market—was never spelled out. In mid-November “Plan A” appeared to have been more or less officially shelved. Never mind that Paulson had told Congress that hundreds of billions for troubled-asset purchases were urgently and immediately needed to avoid financial Armageddon.

On November 25 the idea of troubled-asset purchases made a dramatic comeback under the auspices of the Federal Reserve, which is discussed below.

“Plan” B

On October 13 the Treasury announced a new way to spend $250 billion of the $700 billion: It would inject equity capital into banks, buying newly issued preferred shares. It soon thereafter injected $125 billion into nine major banks: Citigroup, Bank of America, Wells Fargo, JPMorgan Chase, Bank of New York Mellon, State Street, Merrill Lynch, Morgan Stanley, and Goldman Sachs. The last-named is the former investment bank, recently converted into a commercial bank, previously headed by Paulson. From the group of nine banks the Treasury took “preferred shares” with fixed 5 percent dividends (increasing to 9 percent if the shares have not been repurchased in five years).

On November 23 the Treasury announced it would inject an additional $20 billion of equity into Citigroup. For this second injection it took preferred shares with an 8 percent dividend. The Treasury together with the FDIC also provided an off-balance-sheet guarantee against losses on about $300 billion of Citibank’s troubled real estate assets, in exchange for which the Treasury and FDIC took additional preferred shares.

The federal government is now part-owner of the nine banks. The banking system has been partially nationalized. The preferred shares are ownership claims of a type falling between debt obligations (bonds) and common stock shares. They are riskier than bonds because preferred shareholders must stand behind bondholders in the line to get paid in the event that the bank can’t pay everyone.

To compensate for its risk the Treasury also took stock warrants—contracts that give it the right to buy shares in the future at a specified price so that it can make a profit should the banks’ stock prices someday rise higher than that price. “Recapitalizing” a firm normally leads to lower share prices, however, because it means more shares dividing ownership of the same asset portfolio. The infusion dilutes existing shares. For this reason two of the nine banks reportedly objected to participating in the Treasury’s capital infusion with attached strings. The Treasury explained that it did not make participation voluntary because it did not want to stigmatize as weak the banks that chose to participate. A financial analyst’s report in late November named Bank of America, Citigroup, Goldman Sachs, JPMorgan, Morgan Stanley, and Wells Fargo as the weakest institutions.

The other half of the Treasury’s $250 billion has been designated for assignment to smaller banks to be named later. Among other things, the Treasury reportedly hopes these capital injections will enable recipient banks to buy up other, weaker banks. An anonymous Treasury official told reporters: “One purpose of this plan is to drive consolidation.” Thus taxpayer money is being allocated to influence the shape of the banking market.

“Plan” C?

What will “Plan” C be? As the Treasury continues to improvise, everything and anything is possible. So says Neel Kashkari, the former Goldman Sachs employee under Paulson who is now the Treasury’s chief bailout administrator under Paulson. Asked whether funds might go to insurance companies, other financial firms, and even nonfinancial firms like automakers, one news story reported, “Kashkari indicated that everything was on the table. ‘We are looking at everything,’ he said. ‘We are trying to figure out what will provide the most benefit to the financial system.’”

House Speaker Nancy Pelosi, Senate majority leader Harry Reid, and other congressmen have urged the Treasury to use some of the $700 billion to inject capital into the leading U.S. automakers. These same lawmakers specified no such authority in the bailout bill. Some $1.5 billion of the $700 billion will go to local governments for reasons unrelated to the financial system.

Insurance executives have reportedly lobbied for the bailout to include troubled insurance company assets. There is now a precedent: The Treasury has given $67.5 billion of the bailout to AIG, the failed insurance giant brought down by its imprudently massive guarantees on mortgage-backed securities, in exchange for troubled assets and preferred shares. AIG was already on an $85 billion life-support loan from the Federal Reserve.

Second Bailout

The Treasury’s $700 billion bailout is actually the second federal bailout program underway. The press has widely reported on the Treasury bailout bill and the post-bill spending improvisations. Columnists and the public have openly debated the dubious wisdom of that program. Congress has held hearings and has voted on the bailout bill, even if it has left it to the Treasury to decide how the $700 billion will be spent. But flying under the radar, attracting much less public attention and almost zero congressional scrutiny, have been the Federal Reserve’s ongoing efforts that in mid-November added up to a $1.7 trillion shadow bailout program for favored financial institutions, more than double the size of the Treasury’s bailout. On November 25 the Fed announced two new lending lines that will add another $800 billion, bringing the total to $2.5 trillion—more than triple the size of the Treasury’s bailout. (This section draws heavily on my paper for the November 2008 Cato Institute monetary conference, “Federal Reserve Policy and the Housing Bubble.”)

The Fed’s bailout efforts began back in March 2008 with the Fed putting up $29 billion to sweeten a deal in which the commercial bank JPMorgan Chase would take over the teetering investment bank Bear Stearns. A new Fed-owned subsidiary (“Maiden Lane LLC”) was set up to cleanse the Bear Stearns balance sheet by acquiring troubled mortgage-backed securities for the $29 billion. The transformation of the Federal Reserve’s balance sheet, which used to hold virtually nothing but safe Treasury securities, had begun. Between March and November, as the Fed improvised new interventions into financial markets, the dollar amounts of the Fed’s commitments grew and grew.

The interventions are visible among the assets on the Fed’s balance sheet for November 5, where many new entries appear that were absent one year ago. The list begins with “Term Auction Credit” at $301 billion, representing 28-day and 84-day loans to banks. Previously loans to commercial banks were limited to overnight loans for meeting reserve requirements. Banks were expected to attract longer-term funds from depositors or private institutional investors in the money market. Next on the list is “Primary Dealer and other Broker-Dealer Credit” of $72 billion—that is, loans to securities dealers. A year ago the Fed did not lend to securities dealers. Third is the “Asset Backed Commercial Paper Money Market Mutual Fund Liquidity Facility”—loans to banks or bank holding companies to allow them to purchase assets from money-market mutual funds. Previously money-market funds that needed to liquidate commercial paper holdings were expected to sell them in the money market. “Other credit extensions,” a catchall fourth new entry, amount to $81 billion.

The fifth new entry is “Net portfolio holdings of Commercial Paper Funding Facility LLC,” $243 billion. A memo to the Fed’s balance-sheet release explains: “On October 27, 2008, the Federal Reserve Bank of New York began extending loans . . . to Commercial Paper Funding Facility LLC. This LLC is a limited liability company that was formed to purchase three-month U.S. dollar-denominated commercial paper from eligible issuers and thereby foster liquidity in short-term funding markets and increase the availability of credit for businesses and households.” That is, the Fed has formed a new subsidiary for directly allocating funds to a particular segment of the financial system, the commercial paper market. Previously the Fed purchased only Treasury securities, and let private banking and financial markets allocate the funds it thus injected to their best uses.

Sixth is “Net portfolio holdings of Maiden Lane LLC,” $27 billion, representing the troubled assets acquired from Bear Stearns. Note that the assets have been marked down from their acquisition price of $29 billion: the Fed has suffered a loss of $2 billion. By holding the assets the Fed is speculating that the market for selling them will be better later on. Previously the Fed did not get involved in financial takeovers by absorbing troubled assets to sweeten the deal. The FDIC sometimes did, but only in mergers between two insured commercial banks. Bear Stearns was an investment bank, not an insured commercial bank.

Last September the Federal Reserve began buying federal agency notes—short-term IOUs of Fannie Mae, Freddie Mac, and the Federal Home Loan Banks—from securities dealers. As of November 5 the Fed was holding $13 billion of such notes, where it held zero one year ago, though it has held small amounts of agency debt in the past. The Fed’s “primary” (overnight) loans to commercial banks are currently at $110 billion, up from only $1.4 billion a year ago. In total the Fed’s assets have more than doubled, from $889 billion a year ago to an astounding $2.08 trillion in mid-November. Further increases are on the way.

Two items make the Fed’s bailout loan program even larger than the $1.2 trillion increase in its total assets. First, the Fed has funded $303 billion of its new loans by selling off Treasury securities from its portfolio. Second, off its balance sheet (but recorded as a “memorandum item”), the Fed also runs a “Term Securities Lending Facility” that has lent $197 billion of its Treasury securities to broker-dealers, giving them something liquid to sell in exchange for IOUs collateralized by less liquid securities like mortgage-backed securities. As of November 5 the Fed’s new loans and purchases had extended $1.7 trillion in new credits to financial institutions over the past year.

On November 25 the Federal Reserve announced that in the following week it would begin purchasing up to $600 billion in securities issued or guaranteed by Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. It would buy them from its primary securities dealers through “a series of competitive auctions.” It also announced the creation of a $200 billion Term Asset-Backed Securities Lending Facility to make new term loans to financial institutions, loans to be collateralized by nonmortgage pools of consumer and small-business loans. In both cases the Fed is engaged in price-setting, trying to drive interest spreads (the differential yields over Treasury bills required to attract purchasers) on riskier securities back into their historical ranges. Thus the Fed is second-guessing the risk premiums set in competitive financial markets. As of Thanksgiving, the new facilities had not yet appeared on the Fed’s balance shee

Unprecedented Credit Expansion

From $1.2 trillion of added bank reserves, the late-November lending programs (if not somehow offset) will push added bank reserves to $2 trillion. The Fed has no clear exit strategy from its unprecedented credit expansion. It has too few Treasury securities left to sell in order to pull the credits back in, the traditional method for contracting bank reserves. No doubt the Fed hopes that the new loans will be repaid (and not re-extended) as financial market conditions improve. But borrowing firms whose ability to repay depends on the prices of their mortgage-backed securities recovering may be unable to repay any time soon because the effects of overbuilding during the housing bubble will depress the price of real estate and thus of mortgage-backed securities for a long while. Moreover, they may be unwilling to repay. Nonbank financial firms that are now enjoying the Fed’s below-market lending rates will have no incentive to wean themselves and every reason to lobby for keeping the new bargain lending windows open indefinitely. “Temporary emergency” government subsidies have a way of living on and on. Just ask the recipients of federally subsidized farm loans.

The Fed’s new activities deserve to be called a bailout program because they seek to channel credit selectively at below-market interest rates, or purchase assets at above-market prices, in hopes of rescuing, or enhancing profits for, favored sets of financial institutions. The Fed’s new lending facilities are not parts of a central bank’s traditional “lender of last resort” role. A lender of last resort injects reserves into the commercial banking system to prevent the quantity of money from contracting—and thereby to protect the economy’s payment system—when there is an “internal drain” of reserves (bank runs and the hoarding of cash). There has been only one bank run (on IndyMac) and no contraction in the money stock. Investment banks do not issue checking deposits, are therefore not subject to depositor runs, and are not part of the payment system. Neither are securities dealers. Money-market mutual funds play a limited payment role, but because they do not issue demandable debt, they are not subject to runs. The Fed’s expansions of its own activities therefore had nothing to do with protecting the payment system or stabilizing the money supply.

The “lender” in “lender of last resort” has long been an anachronism. Central banks in sophisticated financial systems discovered decades ago that they can inject bank reserves without lending by purchasing government securities in the open market. By doing so, the central bank supports the money stock while avoiding the danger of favoritism associated with making loans to specific banks (or nonbanks) on noncompetitive terms. It also avoids the potential favoritism in purchasing other securities. The Fed’s new activities, by contrast, extend an array of loans to various financial institutions and purchase securities from nonbank issuers and holders. These activities pose the risk of favoritism—of substituting the Fed’s judgment for the market’s about what kinds of institutions and what particular firms should survive. They have nothing to do with replenishing the reserves of the banking system or preventing contraction in the stock of money. The Fed’s activities seem rather to aim at protecting financial institutions from the consequences of imprudent portfolio decisions.

The Federal Reserve’s new interventions into financial markets over the past year have proceeded at its own initiative and without precedent. They seem to be enjoying the complete freedom from oversight that Secretary Paulson unsuccessfully sought for the Treasury’s bailout program. The Fed’s program has attracted little attention mostly because it has not required a congressional appropriation. The Fed is “self-financing”: It can “print up” any funds it needs to make loans or purchase assets by simply expanding the quantity of unbacked claims on itself. This does not mean that Fed credit expansion provides a free lunch. When the Fed increases the stock of dollars, it levies an implicit tax on holders of existing dollar balances by creating an inflationary depreciation of the dollar.

An Evaluation of the Bailouts

The financial turmoil of 2008 was the result of what may be briefly described as a government-policy-induced cluster of entrepreneurial errors by financial-market participants. Paulson’s and Bernanke’s bailout programs are disabling the key market mechanisms for correcting entrepreneurial errors: price adjustments and bankruptcies. Delays in the correction of mortgage asset prices, and delays in the necessary resolution of insolvent financial institutions, do not promote but rather hinder a sound economic recovery. As ABC News commentator John Stossel has written: “We do need protection from reckless businessmen. But there is only one way to provide that: market discipline. That means no privileges and no bailouts.”

When government does not intervene with taxpayer-financed bailouts, private market participants will recapitalize banks (as Mitsubishi Bank recently did for Morgan Stanley) and buy distressed assets in genuinely price-discovering market transactions, to the extent that those risking their own money think warranted. The resolution (sale or liquidation) of firms that are not worth recapitalizing makes room in the market for better-run institutions to take their place. As the United States discovered in the savings-and-loan fiasco of the 1980s, and as Japan discovered in the 1990s, a government policy of keeping insolvent financial firms open beyond their expiration date makes survival more difficult for healthy firms.

Along these lines, the eminent monetary historian Anna J. Schwartz candidly criticized the bailout programs in an interview with the Wall Street Journal on October 18. To promote recovery the Fed and Treasury “should not be recapitalizing firms that should be shut down,” Schwartz said. Rather, “firms that made wrong decisions should fail. You shouldn’t rescue them. And once that’s established as a principle, I think the market recognizes that it makes sense. Everything works much better when wrong decisions are punished and good decisions make you rich.”

Schwartz observed that “Lending freezes up when lenders are uncertain that would-be borrowers have the resources to repay them.” Removing the uncertainty by enforcing the usual rules requiring insolvent firms to exit the market promptly would provide greater clarity to financial markets. The economist Pedro H. Albuquerque has drawn out the implications of this insight: bailout plans make “the information problem worse by keeping unhealthy banks afloat,” which “endangers the entire economy through planned obfuscation.” A hypothetical used-automobile market in which buyers are reluctant to buy because they fear that sellers are trying to palm off unreliable vehicles is known to economists as a “lemons” market. Albuquerque observes that “The government is artificially creating a lemon market when it does not allow discrimination between healthy and unhealthy banks to occur via bank failures.”

Some editorial and op-ed writers have claimed that many financial institutions have been “unregulated” too long and must now become regulated. But financial institutions have never been unregulated. They have been regulated by profit and loss. The failure of Lehman Brothers and the near-failure of Merrill Lynch raised the interest rate at which profit-seeking lenders were willing to lend to highly leveraged investment banks. The market thereby forced Goldman Sachs and Morgan Stanley to change their business models drastically and to convert to commercial banks. If that isn’t effective regulation, what is? Protecting firms from failure (Bear Stearns, AIG, Fannie Mae, Freddie Mac, Goldman Sachs, Citibank) and mitigating their losses with bailouts renders this most appropriate form of regulation much less effective.

The eagerness of Ben Bernanke and Hank Paulson to substitute their own judgment for the dispersed judgments of a freely competitive financial market may reflect simple intellectual error. Or, less innocently in the case of former Goldman Sachs CEO Paulson, it may be error compounded with partiality. In an open letter to Congress on the eve of the bailout bill’s passage, John A. Allison, CEO of the large and successful regional bank BB&T, pointed out that “There is no panic on Main Street and in sound financial institutions. The problems are in high-risk financial institutions and on Wall Street.” The bailout seemed designed, in his view, to benefit a select group of Wall Street firms: “The primary beneficiaries of the proposed rescue are Goldman Sachs and Morgan Stanley.. . . [T]his is primarily a bailout of poorly run financial institutions.” This design, Allison continued, was not an accident but the result of partiality in the designers’ interests and perspective: “Treasury is totally dominated by Wall Street investment bankers. They do not have knowledge of the commercial banking industry. Therefore they cannot be relied on to objectively assess all the implications of government policy on all financial intermediaries.”