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If Stocks Are in Turmoil, Blame the Feds

In financial and investing circles, it is an article of faith that investors abhor uncertainty. Measurable risks are fine, but unknown risks can be deadly.

Unfortunately, both the Bush and Obama administrations are responsible for injecting a staggering amount of uncertainty into the world's financial markets. If you've given up opening your 401(k) statements, or this week's dismal stock market news has postponed your retirement, thank your elected officials for their contribution to this situation.

Since September 2008 -- a mere five months ago -- the Feds let Lehman Brothers fail while seizing control of Fannie Mae and Freddie Mac and rescuing insurance giant AIG. It temporarily suspended investors' ability to bet on price declines in some stocks, but not others. It has bailed out some failing companies and ignored the pleas of others.

The latest idea: To allow mortgage contracts to be rewritten after they'e been signed. A House of Representatives committee has approved a proposal to allow bankruptcy judges to lower the interest rate and the amount owed on existing loans; a companion bill is pending in the Senate.

Does anyone think this will encourage investors to buy mortgages or the banks that write them? Or that only existing mortgages will qualify? Goldman Sachs CEO Lloyd Blankfein told a House panel that a potential consequence is "less capital flows into this market." George Mason University economics professor Todd Zywicki noted that not only will interest rates rise and foreclosures increase, but it would "exacerbate the already existing uncertainty in the financial system."

Then there's the shapeshifting Troubled Assets Relief Program, or TARP. It was sold to the public as a means to buy toxic assets from banks that nobody else wanted to touch. Then it morphed into the Treasury buying chunks of businesses outright and receiving preferred stock in return.

President Bush initially claimed that TARP couldn't be used for a Detroit bailout, in part because the legislation refers to "financial institutions," but he changed his mind in December and wrote a multi-billion dollar check. Treasury Secretary Timothy Geithner announced yet another set of TARP rules on his first day in office.

Perhaps some of these measures are necessary. Perhaps they're not. But a collection of rules that seem to be constantly in flux is no way to reassure investors already rattled by a worldwide recession that is sharp and severe. Talk of outright bank nationalization, which the New York Times reported is taking place in the Obama administration, isn't helping.

The phrase that describes this situation is "regime uncertainty," coined by Robert Higgs, an economic historian who edits the quarterly journal of the Independent Institute in Oakland, Calif.

Higgs wrote a 1997 article on the Great Depression that highlighted a telling fact: gross private investment dropped from about $1.2 trillion in the late 1920s, remained under $1 trillion for most of the 1930s, and did not resume its usual upwards trajectory until 1946, after President Truman took office and World War II ended. (Figures are in 1987 dollars.)

Early in his presidency, Franklin Roosevelt was sensitive to the possibility of making the depression worse by undermining business confidence. But within a few years, he and his advisors had come to view business leaders as adversaries to be targeted with a host of new laws and regulations -- including 75 percent marginal tax rates. By November 1941, a Fortune poll of executives found that over 40 percent predicted the emergence of a fascist, socialist, or "semi-socialized society in which there will be very little room for the profit system to operate."

Lammont du Pont, the great-grandson of the legendary founder of the DuPont chemical company, said in 1937: "Uncertainty rules the tax situation, the labor situation, the monetary situation, and practically every legal condition under which industry must operate. Are taxes to go higher, lower or stay where they are? We don't know. Is labor to be union or nonunion?... Are we to have inflation or deflation, more government spending or less?... Are new restrictions to be placed on capital, new limits on profits?... It is impossible to even guess at the answers."

Sound familiar? How about this quotation about the problems of unpredictable political systems: "If it is changing every week, how can you expect me to have confidence?" That was Lou Jiwei, the chairman and chief executive of China's influential sovereign wealth fund, speaking in December 2008.

Nobody is saying that economic conditions today are the same as the Great Depression; even with the turmoil on Wall Street, they're clearly not. And unemployment has yet to come close to where it was as recently as 1982. Obama's advisors don't seem to share Roosevelt's hostility to business, and it's true that investors always have had to make bets based on expected government policies.

Yet the political unpredictability then is starting to echo today's. "I think there are parallels," said Higgs, the economic historian, in an interview this week. "This situation we're in now is fraught with regime uncertainty... (especially) if private property has no substance because no contracts are durable and enforceable and create stable expectations. I think they're already reacting this way in the financial markets."
Most of today's economic turmoil has been caused by the bursting of a series of historic asset bubbles and prices resetting to post-bubble levels. But it's been aggravated by regime uncertainty under Bush and Obama -- and, alas, there's no indication that our elected officials realize the harm that such erratic actions can cause.

Declan McCullagh is the chief political correspondent for CNET. Previously, he was Wired's Washington bureau chief and a reporter for and Time magazine in Washington, D.C. He has taught journalism, public policy, and First Amendment law. He is an occasional programmer, avid analog and digital photographer, and lives in the San Francisco Bay area. His e-mail address is