4 Economic Moves the Government Got Right

There have been screw-ups, but new evidence shows that federal intervention rescued the economy.

By SHARE

Back in early May, the stock market looked as though it had rebounded from the depressing lows it had reached in March, but stocks still seesawed as investors vacillated between hope that the worst was behind and fear that nasty surprises still lay ahead. Then on May 7, the Federal Reserve released the results of its "stress tests" of the nation's 19 biggest banks. They showed that half were healthy, most of the rest would be OK if they raised reasonable amounts of capital, and only two or three were really in bad shape.

The markets yawned. On CNBC and Fox News, critics of the Fed rolled their eyes. Some said the Fed's methodology was too soft, others said its analysis was a whitewash that hid catastrophic problems at the banks. But over the next few weeks, that attitude changed as most banks raised the required capital, investors gained confidence, and a huge rally in financial stocks led the strongest bull market in decades.

[See 9 signs of America in decline.]

In retrospect, the stress tests, piled upon a huge stimulus plan and a series of corporate bailouts, seem like the turning point that helped the economy regain forward momentum. "The stress tests were the first shot of confidence the market had had in quite some time," says John Linehan, codirector of U.S. Equities for investing firm T. Rowe Price. "Federal stimulus and the loosening of credit created an environment for a market rally."

It's fashionable (and effortless) to bash the government these days, since it's a fat target for anybody dissatisfied with some aspect of the economy. And there certainly have been some screw-ups, like the black-hole bailout of AIG and the $3.6 billion in bonuses that went to executives at Merrill Lynch while its parent company, Bank of America, was effectively a ward of the state.

But you'd have to be Ayn Rand's evil twin to believe government intervention hasn't helped the economy at all. It's perfectly valid to question whether $787 billion in stimulus money could have been better deployed or whether the Wall Street bailouts will ever trickle through to Main Street and the real economy, as intended. But antigovernment, tea-party nihilism overlooks the fact that when free markets fail, the government is usually the only party able to restore order. And determining what the government accomplished over the past 18 months will guide the fierce debate in Washington over how to regulate the banks and prevent more meltdowns in the future.

So here's a short list of what the government got right:

It got the economy growing again. After shrinking for four quarters in a row, the economy finally began to expand again in the third quarter, growing 2.8 percent. "The GDP growth was mostly, if not entirely, fueled by monetary and fiscal support from the federal government," writes Mark Zandi of Moody's Economy.com. "Cash for clunkers, tax cuts, and aid to unemployed workers drove consumer spending, and the tax credit for first-time home buyers supported gains in home building." It would be better if the economy were growing without government aid—but it would be a lot worse if the economy were still shrinking. Most economists expect the economy to grow by 3 to 4 percent in the fourth quarter as well and then slow down again next year as the stimulus spending runs its course. That's when the private sector will get to prove whether it can pick up the slack.

[See how the government is swallowing the economy.]

It kept the housing market alive. The home-buyer tax credit—now extended into 2010—has been one of the few incentives for spooked consumers to come out of their bunkers and spend a bit of money on real estate. And with private lenders cowering in their vaults, the federal government is now underwriting 70 to 80 percent of all new mortgages, thanks to the rescue of Fannie Mae and Freddie Mac. The housing bust still isn't over, but we seem to be getting close to the bottom in terms of home-price declines. That's essential for a broader economic recovery to take root. If we waited for the private sector to pick up the slack, it would take years longer and probably entail exaggerated price drops well below the equilibrium levels dictated by supply and demand, forcing us to dig out of an even deeper hole.

[See the best and worst government bailouts.]

It helped restore credit. In the fall of 2008, after the financial markets collapsed, it seemed possible that nobody, not even the wealthiest corporations, would be able to get a loan. That was a doomsday scenario that would have led to mass layoffs on a scale far worse than what actually happened. A series of financial maneuvers, mostly by the Federal Reserve and the FDIC, have slowly rebuilt confidence and brought some lenders back to the table. Many businesses and consumers still can't get loans they feel they're qualified for. But we've been through a near-death experience in the credit markets, and healing is underway.

It fueled a stock market rally. Investors hate uncertainty and are most likely to keep their money safe, in cash, if they're worried about the risk of major economic disruptions. That's what they did in late 2008 and early 2009, when the market plummeted. Since the March bottom, however, the S&P 500 has soared by 65 percent, one of the greatest bull markets in modern history. That would never have happened if investors feared further financial collapses or a continued downward spiral in the credit markets. It took far longer and cost more than anybody would prefer, but government shock therapy finally convinced investors that the banks were safe and normal economic conditions would return without a prolonged period of distress.

[See how free-market failures helped cause the recession.]

There's a lot the government hasn't been able to do, like stimulate job growth or arrest a soaring foreclosure rate. Many of the Wall Street bailouts now seem unnecessary at best and repulsive at worst. And we may yet regret such profound government involvement in the financial sector, the auto industry, and the housing market. As sloppy as it has been, however, the government has rescued the foundering U.S. economy from a much more painful fall, leaving America bruised but not broken. Too bad the so-called free market isn't as good at rescuing itself.