Gordon Does Good

The Gordian solution to knotted financial markets cuts through "to the heart of the problem," while the Paulsian solution appears to be "distorted by ideology" that prevents bold Alexandrian action:

Gordon Does Good, by Paul Krugman, Commentary, NY Times: Has Gordon Brown, the British prime minister, saved the world financial system?

O.K., the question is premature — we still don’t know the exact shape of the rescues in Europe or … the United States, let alone whether they’ll really work. What we do know, however, is that Mr. Brown and Alistair Darling, the chancellor of the Exchequer (equivalent to our Treasury secretary), have defined the character of the worldwide rescue effort, with other wealthy nations playing catch-up. …

What can be done to stem the crisis? Aid to homeowners, though desirable, can’t prevent large losses on bad loans, and in any case will take effect too slowly to help in the current panic. The natural thing to do, then — and the solution adopted in many previous financial crises — is to deal with the problem of inadequate financial capital by having governments provide financial institutions with more capital in return for a share of ownership.

This sort of temporary part-nationalization,… often referred to as an “equity injection,” is the crisis solution advocated by many economists — and sources told The Times that it was … privately favored by Ben Bernanke…

But when Henry Paulson … announced his plan for a $700 billion financial bailout, he rejected this obvious path, saying, “That’s what you do when you have failure.” Instead, he called for government purchases of toxic mortgage-backed securities, based on the theory that … actually, it never was clear what his theory was.

Meanwhile, the British government went straight to the heart of the problem … with stunning speed. On Wednesday, Mr. Brown’s officials announced a plan for major equity injections into British banks, backed up by guarantees on bank debt that should get lending among banks, a crucial part of the financial mechanism, running again. And the first major commitment of funds will come on Monday — five days after the plan’s announcement.

At a special European summit meeting yesterday, the major economies of continental Europe in effect declared themselves ready to follow Britain’s lead… And whaddya know, Mr. Paulson — after arguably wasting several precious weeks — has also reversed course, and now plans to buy equity stakes rather than bad mortgage securities (although he still seems to be moving with painful slowness). 

As I said, we still don’t know whether these moves will work. But policy is, finally, being driven by a clear view of what needs to be done. Which raises the question, why did that clear view … come from London rather than Washington?

It’s hard to avoid the sense that Mr. Paulson’s initial response was distorted by ideology. Remember, he works for an administration whose philosophy of government can be summed up as “private good, public bad,” which must have made it hard to face up to the need for partial government ownership of the financial sector.

I also wonder how much the Femafication of government under President Bush contributed to Mr. Paulson’s fumble. All across the executive branch, knowledgeable professionals have been driven out; there may not have been anyone left at Treasury with the stature and background to tell Mr. Paulson that he wasn’t making sense.

Luckily for the world economy, however, Gordon Brown and his officials are making sense. And they may have shown us the way through this crisis.