Politicians too late in responding to the threat of a recession

WASHINGTON -- So where were all the politicians who are now saying, "Hurry up! Fix it!" about the looming recession, back when the economic mess was brewing? Most of them were focusing on other issues. And now that the slowdown has begun, it may be too late to blunt its effects.

That's one of the dirty little secrets about economic policy: The response to a crisis is often too late. As a result, the lag in policy often has a pro-cyclical effect -- a stimulus package that juices the economy after the recovery has begun, or a cut in interest rates that encourages more lending well past the time it would do most good.

What's infuriating is that the problems in the housing market were clear to everyday folks long before they registered with the geniuses at the Federal Reserve and the Treasury Department. In fact, that's why we are heading into a recession now -- because consumers and business managers realized last fall that there was something seriously out of whack in the housing sector, and began trimming their spending and investment. The result is the pattern we are now seeing, of declining retail sales and rising unemployment.

Here's what neophyte Fed Chairman Ben Bernanke said back in May, when warning signs about a mortgage squeeze were already flashing red: "The effect of the troubles in the sub-prime sector on the broader housing market will likely be limited." Sorry, but that was not the correct answer.

Wall Street traders saw a housing crunch coming, and the smart ones were aggressive enough to profit from it. The Wall Street Journal last week profiled a hedge fund manager named John Paulson who made between $3 billion and $4 billion over the past year betting the shaky structure of sub-prime mortgage loans would topple.

In late 2006, Goldman Sachs' Chief Financial Officer David Viniar decided the bank should reduce holdings of mortgages and mortgage-backed securities and buy insurance against further losses.

And what was Goldman's former chief executive, Secretary of the Treasury Henry Paulson -- doing about the looming crisis? Sad to say, the answer is very little.

Even journalists saw this one coming. In December 2005, Kirstin Downey, who covered housing at the time for The Washington Post, wrote an article headlined: "Mortgage Stress Seen for '06; Delinquencies on Sub-prime Loans Seen Likely to Spike, Report Says." She continued to write warnings about the sub-prime mess through 2006. It's eerie reading them now, like watching a replay of a car wreck.

Steven Pearlstein, a financial columnist at the Post, wrote some of the sharpest warnings about what was ahead. In a prescient March 2007 column about the gimmicky loans that fueled the sub-prime disaster, he wrote: "What we have here is a failure of common sense."

Now congressional Democrats and the Bush White House are jostling over a stimulus package to reduce the damage -- with presidential candidates shouting advice from the wings. It reminds me of Hurricane Katrina, with frantic action after, but little caution beforehand.

Economists, who have a theory for everything, have come up with an explanation for this chronic tendency to delay until it's too late, and then scream for action. "Procrastination and Impatience" is the title of a paper published in December by the National Bureau of Economic Research. The authors concluded: "Our results lend support to the hypothesis that subjects who have a preference for immediacy are indeed more likely to procrastinate."

So there you have it: Our political process is a self-frustrating machine. Our politicians want immediate action, but only after they have delayed to the point that it will be ineffective.

© 2008, Washington Post Writers Group