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Jewish World Review Jan. 24, 2001 / 29 Teves, 5761

Amity Shlaes

Amity Shlaes
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Consumer Reports

A gloomy end for a half-hearted undertaking -- CALIFORNIA'S power crisis is exploding into a national storm, billed as the first big challenge for President George W. Bush. The new administration swears up and down that there will be no federal bail-out for the flailing utilities and power-starved citizens.

Really? If the Bush team holds fast, it will be the first administration in living memory to withstand the temptation to play the rescuer in the face of a consumer problem of this magnitude.

A federal bail-out would be a costly mistake. Even pricier would be the impact of a federal bail-out on America's political culture. The West Coast misadventure has already smeared the national reputation of power deregulation - and even of the principle of deregulation in general.

What was once viewed as a bold experiment in market rationalisation is fast morphing, in the public's eyes, into an example of base profiteering and customer abuse. Gray Davis, California's governor, has led the retreat into populist rage, telling citizens that "never again can we allow out-of-state profiteers to hold California hostage".

Such robber baron rhetoric obscures a simple fact. California deregulation did not fail. It never had a chance to: the state's government intervened before utilities could expand supply to meet fresh demand. In states such as Texas - where intervention and environmentalist delays are less common - deregulation has worked just fine.

The acute Californian shortages of the past half year stem not from deregulation so much as from its opposite. Utilities must buy power wholesale at the market's high prices but are blocked - through price caps backed by Mr Gray - from passing the new increases along to their customers. You do not need an economics degree to see what is wrong with that.

In eastern Europe and developing countries, the name of free enterprise is routinely besmirched by faux deregulatory efforts - or partial privatisations the benefits of which flow exclusively to one or another set of privileged rent-seekers. But the west is supposed to lead the way in such reforms and the failure here is particularly damaging. Surely the US should be able to restore a slice of the state sector to private hands.

Consider the parallels with a deregulatory debacle that emerged during the time of Mr Bush's father: the savings and loan crisis.

Consumers still expect to get their power from a big, reliable, government-backed entity. The same then held for the savings and loans, traditional banks at which citizens held home mortgages. From the 1930s onwards, Washington regulated these "thrifts" in a number of ways. The thrifts were constrained from giving loans outside the residential property sector. There were caps on loan and deposit interest rates. Washington early on protected depositors by guaranteeing the safety of deposits up to $5,000 and periodically ratcheted the figure upwards after that.

As with energy, this benevolent stewardship generated enormous and predictable inefficiencies. In the 1970s, inflation brought high interest rates. Yet the law forced the thrifts to lend and take deposits at lower, capped rates. This benefited homeowners but starved the thrifts of deposits. Citizens continued to borrow from the thrifts at favourable rates but transferred their deposits to the new money market, which offered higher returns. They did this in spite of the fact that money market accounts did not enjoy the benefit of a federal guarantee.

Washington decided to help the thrifts out by allowing them to lend in new areas such as commercial property. But as with energy, the much- trumpeted deregulation was partial - and so a sham. For Washington did something to ensure its new "free market" thrifts would not suffer too much: it more than doubled the level of federal deposit insurance to $100,000, thus massively expanding government exposure to the problems of the sector.

Giving the thrifts freer rein while guaranteeing the safety of their depositors established a classic situation of moral hazard. Unwise thrift executives plunged into the volatile commercial property market; lawmakers looked the other way in exchange for political contributions from the savings and loans. The most infamous of the wayward thrifts was Arizona-based Lincoln Savings and Loan, which hawked risky debentures direct to those in retirement.

In the end, the bill for the whole story landed in Washington's lap, just as the power question now threatens to do. The cost of the bail-out ran into the thousands of millions - sufficient to hurt George W.'s father's campaign for re-election. But the bigger casualty was the reputation of deregulation. As Robert Bartley of the Wall Street Journal points out in his book The Seven Fat Years, the problems of the thrifts became a rallying cry for anti-deregulation forces.

A letter from the Democrat senator John Glenn, quoted by Mr Bartley, is typical: "Deregulation was a pillar of Reaganomics," wrote Mr Glenn. "Yes, and the American people will be paying for that for over 50 years. With banks failing, thrift bail-out costs rising and insurance companies shaking, now is no time to be nostalgic about deregulation." Governor Davis, whose political ambitions range well beyond the state capital in Sacramento, can likewise be counted upon to wave the anti-deregulatory flag in future.

To be sure, partial deregulation alone cannot be blamed for all the troubles experienced by the thrifts and the California utilities. In both cases, big external shocks - inflation for the thrifts and wholesale energy price increases for the utilities - aggravated the problems immensely. In the case of the thrifts, corruption also played a part. Still, the outlines of a lesson emerge: half a deregulation can be worse than none at all.

JWR contributor Amity Shlaes is a columnist for Financial Times . Her latest book is The Greedy Hand: How Taxes Drive Americans Crazy and What to Do About It. Send your comments by clicking here.


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