WASHINGTON, D.C. -- In contrast to the Bush administration's happy talk about a gradual economic recovery, dark clouds drift over the nation's great money centers. A liquidity crisis is well-developed, nourished by congressional hysteria and demagoguery over the bankruptcy of Enron Corp.
"Whenever you have a liquidity crisis, the last thing bankers are going to do is warn about a liquidity crisis," a corporate financial expert (who asked not to be identified) told me. "They worry it might set off a panic." As an example, he cited the lack of warnings three weeks before the newly inaugurated President Franklin D. Roosevelt was forced to close the nation's banks.
The economic climate in 2002 is nothing like Depression-racked 1933. Nevertheless, corporate financing is blocked in what is variously called a credit crunch or a liquidity crisis. The situation has been building since 2000, but this is not the kind of problem that government officials cope with easily or even understand. Just this week, a puzzled but very worried senior official in the Bush administration asked an outside consultant whether the "credit crunch" is local or national.
The blunt analysis by financial experts is that it is national. The nation's three great banks -- CitiGroup, J.P. Morgan Chase and Bank of America Corp. -- are simply not lending to each other. What worries banking insiders is that they will "not give each other liquidity." That reluctance trickles down to stop the flow of capital required by capitalism.
Various factors are blamed for this dangerous condition. Federal Reserve Chairman Alan Greenspan is widely accused of keeping money too tight for too long during his 1999-2000 war against inflation. Securities and Exchange Commission (SEC) regulations during the Clinton administration widened the interest-rate gap between run-of-the-mill businesses and high-grade corporations. The Enron scandal and its reverberation contribute to the liquidity crisis.
The "cure" for Enron, however, could deepen the malady. This is made clear in a new paper by Frederick L. Feldkamp, a Chicago lawyer who has advised major American corporations. "Markets are equally threatened by (1) the abuse portrayed in the Enron scandal and (2) self-righteous overreaction that threatens to convert the annual corporate audit process into a rolling inquisition," Feldkamp writes. He notes that "lack of liquidity ... almost always means the death" of a firm, and the reaction to Enron threatens that fate.
Nobody, certainly not Feldkamp, is defending the Enron crowd. The use of the word "inquisition" means that Feldkamp is alarmed by histrionics of lawmakers from both parties, who delight in getting television exposure to excoriate Enron executives appearing before multiple congressional investigations.
Beyond poisoning the atmosphere, however, Feldkamp is concerned about another impact of Enron's fraudulent accounting procedures, which took losses off the balance sheet. It could prevent the use of legitimate "off-balance-sheet" transactions, especially in the secondary mortgage market. Feldkamp asserts that "the nation cannot afford to let this scam (Enron) interfere with legitimate transfer transactions."
Last July, Feldkamp asked this question about interest rate spreads between high-grade and ordinary companies: "Can rising spreads be reversed before the U.S. economy falls into a liquidity trap and drags the world into a recession?" The spreads clearly have not been reversed.
The recent buzz around Washington and New York is that, in view of the supposed economic recovery, Chairman Greenspan would change the central bank's bias from loosening to tightening. Nothing seems more counterproductive in the midst of a credit crunch, though the Fed over the years has been infamous for such mindlessness.
However, Feldkamp and supply-side consultant Jude Wanniski, who agree on little, do share one key view. They correctly predicted that repeated cutting of interest rates by the Fed would not cure deflation. Wanniski says it is necessary to inflate, pushing up the price of gold. Feldkamp proposes a series of accounting reforms. There is no sign that either the administration or Congress has even diagnosed the ailment, much less prescribed a remedy.
Meanwhile, the nation's money centers remain quiet in their distress that Capitol Hill's reaction to Enron indeed is becoming a prolonged inquisition with lamentable consequences for the country. Self-restraint is a lot to ask of politicians.