The biggest enemy to the end of the financial crisis and the beginning of an economic recovery is Treasury Secretary Henry Paulson himself. Let’s forget for a minute that the decision by Paulson and Bernanke to let Lehman Brothers fail was the precipitating event leading to credit markets freezing up and the first round of financial panic. Since then, the two have been working diligently to correct this colossal mistake. But separating actions from words, we see that words are in fact much more potent.
Since the end of September, every time Henry Paulson has opened his month, the Dow has dropped on average 196 points. On days when he was silent, the Dow has dropped on average 28 points.
September 26, 2008 to December 1, 2008
|Paulson Silent (Dow Change)||Paulson Speaks (Dow Change)|
|28 points||196 points|
So whats going on here? When the crisis started spiraling out of control after the Lehman failure, Henry Paulson and Ben Bernanke swiftly stepped in with bold action, taking over AIG, preventing further failures, and proposing an unprecedented bailout fund of $700 billion. That was all somewhat re-assuring. But when congress waivered, Henry Paulsons second monumental mistake was appealing directly to the public, telling them if he didn’t get the package the US would face the next great depression.
And the world responded. “Great depression?” they gasped. Consumer confidence plummeted, as did consumer spending (which accounts for a stunning 2/3 of US GDP). Corporations, in a mass panic, swiftly switched into a mode of panicked layoffs and cost cutting. The banks, already spooked, continued to tighten their lending not just to consumers but to corporations and other banks as well. And ditto for the rest of the world.
Economics is as much or more about confidence and psychology than it is about fancy macro or micro-economic theories. So here we are. Every time Henry Paulson opens his mouth, he spouts some more doom and gloom. The US and world economies are in ful fledge panic. Everyone, from gas station attendants to corporate CEOs are talking authoritatively about great depressions, cutting costs and spending, and general doom and gloom.
And its a self fulfilling prophesy. If people think there will be a depression, and change their behaviors accordingly, there will be.
What we need now is for Henry Paulson to shut up and go about the business of stabilizing the economy quietly. Silence is golden, and will pay of (literally) in gold. Its time for confidence to heal and markets to stabilize so that the next Treasury Secretary and the next administration can implement their own set of policies.