With the dizzying pace of government intervention into the financial services market, it is not too soon to begin planning for the elimination of the intervention.
As the government makes decisions on intervention, it should also consider what the exit strategy from that intervention might be, and it might find that the process leads to slightly different intervention. To do so systematically, the government needs to assign responsibility on an interagency basis immediately, and to give resources to those to whom the assignment is given.
With respect to the purchase of $125 billion of preferred shares in the largest institutions, it appears that careful thought was given to the manner by which withdrawal will occur. After three years the preferred is callable at par, and before that it can be retired through substitution of a new issue of Tier 1 equity. After five years, the dividend on the preferred moves from 5% to 9%, thereby providing another trigger point which will encourage the elimination of the shares. Similarly, the restrictions on executive compensation and the warrants the government obtains also are incentives for exit.
Imbedded in the increase in deposit insurance is a termination date, but there is no integrated phaseout of the program contemplated by the documents that create it. Similarly, the program that establishes the government guarantee of the money market funds does not provide a blueprint for dismantling itself. The housing GSEs have been placed into conservatorship, but there is no program mandated for moving them out of conservatorship. While the asset purchase program terminates at a fixed time, there is no fixed period during which the government must dispose of its ownership position in the purchased assets.
Flexibility in the programs is essential not only because of the speed with which they had to be adopted, but also because precise prediction of the future movement of the economy is not possible. Mandates established coterminously with the creation of the programs might create more problems than they solve.
Nevertheless the existence of these programs may well generate a dependency in the market. Under one program first designed as temporary, savings institutions were to have a differential advantage in pricing savings deposits. The program lasted for decades, and was only eliminated through the creation of a government-administered depository institution deregulation commission.
During their existence, temporary programs often create unintended consequences. One classic example is the establishment of the money market fund industry (whose accounts the government now is guaranteeing) in 1969. A Depression-era program which permitted the Federal Reserve to establish interest rates for banks made it impossible for individual savers to protect their savings when interest rates skyrocketed into double digits in the late 1960s and the cap on interest that banks could pay stayed at 5.5%, ostensibly to avoid disastrous rate competition among the banks. Utilizing the most simple of arbitrage, a multitrillion-dollar industry was created that long survived the elimination interest rate cap that created it.
While there may be many solutions to avoid the problems which come from long-lasting intervention, it seems that a very reasonable one would be to establish a working group within the government with the sole responsibility to determine how best to extract the market from the entanglement of these interventions.
The group should have a chairman, members from the appropriate agencies, and an advisory committee that would include members of Congress, if possible. Establishment could be done informally at the instigation of the president, or perhaps even the secretary of the Treasury.
The meetings need not be public, nor need there be a cloak of secrecy about them, and they should provide recommendations to Congress for methods of terminating the intervention in various parts of the system no later than late spring or early summer of 2009.
There is wisdom in Milton Friedman's quip that no program is so permanent as a temporary government program. While keen minds are needed to establish the unusual programs that will move the country past its present economic problems, similarly keen minds need to be thinking now of strategies that will permit smooth exits from these programs.
