In this week’s Barron’s, Jack Willoughby interviewed Anna Schwartz, one of the most respected economists of our time. Ms. Scwartz felt that the bailout plan was too opaque and ad hoc to work. Ms. Schwartz who is 93 has worked with the National Bureau of Economic Research since 1941 and remains an adjunct professor emeritus at the Graduate Center of the City University of New York. Noted writer Ben Stein believes Ms. Schwartz’s failure to receive the Nobel Prize in Economics stems from sexual prejudice.
Ms. Schwartz has spent most of her life studying how changes in the money supply interact with inflation. She does not like the unprecedented lending by the Federal Reserve Bank and the Treasury.
Barron’s: What are your regrets about government’s handling of the credit crisis?
Schwartz: If I regret one thing, it is Milton Friedman is not alive to see what is happening today. It is like the only lesson the Federal Reserve took from the Great Depression was to flood the market with liquidity. Well, it is not working. Professor Friedman would have enough stature to get them to listen and stop pooh-poohing any notion of possible inflation
Barron’s: Accountability or its absence is a theme of yours.
Schwartz: The Federal Reserve has used its balance sheet in ways never before seen, leveraging it by 25%.
Barron’s: Do you believe that the real problem comes not so much from troubled mortgages but the inability of banks to price securities they have created in the secondary market?
Schwartz: The problem comes from the introduction on new instruments and the difficulty in pricing these securities or pools of mortgages. To make matters worse the rating agencies came up with ratings in an arbitrary manner without really doing due diligence.
The problem comes from a lack of ability to price credit-default swaps… We do not know who is solvent and who is not. Evidence is that banks are not lending to each other.
Barron’s: How do you coordinate rescue programs both domestically and overseas?
Schwartz: We have an obligation to help clean up Europe because we persuaded investors there to buy these securities, because of their high ratings, and they have been left high and dry.
Barron’s: But you content that the most work needs to be done on the Paulson plan
Schwartz: The $700 billion Paulson package represents further problems because of the ad hoc way it seems to be cobbled together. No one has come up with a way to price these new securities.
Barron’s: But won’t all these multi-billion-dollar programs in time create inflation?
Schwartz: The Fed credit appears to have ballooned greatly and that is behind the upward pressure in the consumer price index. Paul Volker learned that success in fighting inflation comes from tightening monetary policy, even if the public holds you responsible for deflation.
Barron’s: Just how high are the stakes?
Schwartz: The risk of being unclear and doing things ad hoc is that you gradually destroy faith in the financial system. And complete loss of faith leads to the imposition of bank holiday, the closing down of the system, to reassure the public of the solvency of banks…
But if we keep making things more uncertain, and feeding the fear without minimizing the problems, we could eventually make it so that Americans lose faith in their financial system. The chief problem with the Paulson proposal is that recapitalizes both solvent and insolvent institutions.
Originally published in the Sarasota Herald-Tribune
