The Republicans are Responsible for the Crisis

It is oddly reassuring that the Treasury Department and Federal Reserve let Lehman Brothers fail, did not subsidize the distress sale of Merrill Lynch to Bank of America, and tried to line up loans for the American International Group, the troubled insurer, rather than making a loan themselves. Government intervention would have been seen either as a sign of extreme peril in the global financial system or of extreme weakness on the part of federal regulators.

Instead, the dizzying events on Wall Street suggest that the system may be strong enough to absorb the downfall of Lehman and Merrill — though the chaos at A.I.G. seems harder to swallow. However, the stock market’s initial reaction — a brutal drop, but not a Black Monday-style sell-off — offered a ray of hope that the disruptions may be manageable. And, more important, barring the risk of cascading failures, regulators finally seem willing to hold Wall Street accountable for its mistakes.

Lehman’s bankruptcy filing may even provide much-needed transparency to a financial system that has been hamstrung for more than a year by a lack of good information — on who owns what and who owes how much and to whom. Lehman’s creditors and other firms involved in its trades will now have to line up in bankruptcy court, detailing their positions for all to see — and learn from. That did not happen in the spring when the Fed prevented a bankruptcy filing from Bear Stearns to avoid what it said would have been a systemwide failure.

Still, the disappearance in one weekend of two icons of American capitalism has negative repercussions, for taxpayers and for the economy.

The Fed has broadened yet again its emergency-loan programs for Wall Street banks, agreeing to take risky and poor quality collateral, like junk bonds. That puts taxpayers at ever greater risk. Remember, the Federal Reserve already put the taxpayers on the hook by offering $29 billion in guarantees to quell the Bear crisis in March. This month, the Treasury Department pledged to make good if need be on trillions of dollars of obligations of Fannie Mae and Freddie Mac.

In addition to the sheer size of the government’s commitments, the weakening economy is upping the odds that taxpayers will be footing the bill for the wipeout on Wall Street. As job losses have risen inexorably this year, foreclosures hit another record high in August — 304,000 homes in some stage of default and 91,000 families losing their homes, according to RealtyTrac, an online marketer of foreclosed properties.

As long as foreclosures continue, housing prices will continue to decline and banks and other financial firms will continue to suffer losses. Continuing losses, in turn, could force more taxpayer bailouts, by reigniting fears that ongoing failures may threaten the entire financial system. Preventing foreclosures is the key to stanching the crisis, but policy makers have been unconscionably slow to address that aspect of the crisis.

It will require political will, but is not too late to try to decrease foreclosures by allowing homeowners to restructure their unaffordable mortgages in bankruptcy court. It is also not too late to stimulate the economy with intelligent government support, like aid to state and local governments, rather than campaign-year gestures like the tax rebates for virtually everyone that dominated the first stimulus package.

And it is certainly not too soon to look beyond the current crisis to the flaws and fallacies of the anti-regulatory ideology that has held Washington in its grip since the Reagan years and allowed the financial excesses that are now stressing the system to the breaking point.

Making and enforcing new rules is necessary, but that will not be enough. The nation needs a new perspective on the markets, one that acknowledges the self-destructive bent of unfettered capitalism and its ability, unchecked, to wreak havoc far beyond Wall Street.