Heading for Disaster

The dangers of building a new social contract between government and citizens by making it up as we go along.

In a couple of weeks last September, the Federal Reserve and Treasury Department made more lightning- fast decisions, involving more government money, than at any time in the nation's history. This was much bigger than a mega-rescue of the nation's financial system. It was a big step toward redefining the social contract about what government does for all of us-and how it does it. The Fed and Treasury jumped in with the hope that the bailout would be brutally tough but relatively short and antiseptic. Sop up the toxic mortgages, free borrowing that had become frozen, and the Bush administration hoped the economy would right itself. But this plan (think of it as Phase I) didn't work. As President Bush later confessed, "This is a difficult time for a free-market person."

That led the administration in its waning days to Phase II: a shift from a hope in a self-correcting market to a conclusion that government not only had to fuel the economy but also to grab its wheel. Then President Obama intensified the shift with his own dramatic plan for the government to devote hundreds of billions of dollars to an economic stimulus program. It's now clear that we've committed ourselves to a process of building a new social contract that will be brutal but also huge and wide. We're escalating our commitments without a plan about where to go or how to get out.

Phase II is about much more than pumping out lots of cash. We also want to do big things with it. We want to save the banks and help individual mortgage holders. We want to bandage state budgets and rebuild local infrastructure. We want to help the auto companies, save employees' jobs, and build a new generation of fuel-efficient cars.

That involves more than an all-lobbyists-on-deck call. Everyone realizes this is a historic opportunity to use government's cash to promote big economic and social goals. But milliseconds after that cash started to flow, demands surfaced for tougher rules to prevent the crisis from happening again. And along with the funding came the irresistible urge to use the money to pursue a wide array of economic and social goals-often laudable, but frequently conflicting.

The New Social Contract

Lots of crosscutting requirements have become attached to federal cash over the years. No one who takes a nickel of Uncle Sam's money can discriminate on the basis of race, religion, or other factors. Planners using federal funds for projects must first assess the environmental impact of new construction. Government-funded facilities must be handicap-accessible. As the bailout rolled out, giant investment banking firms meekly became banking holding companies, with tighter government regulation, as the price of a cash infusion.

On the one hand, no one actually likes all the rules. Government souvenir shops still sell acrylic-encased bits of genuine government red tape, once used to bind Civil War-era veterans' files. (Cutting the red tape was the only way to get into the files to determine the benefits for which the vets were eligible.) But on the other hand, when public money starts to flow, we can't resist the temptation to use red tape to direct what the money does. As we moved from Phase I to Phase II of the financial bailout, we shifted from trusting the market to insisting on government's firm hand on the wheel. Now that government is in the game, it's in deep. We're heading for a public role in private life that's unlike anything we've ever seen before, and many features are likely to be permanent.

We've long been sliding into a more expansive government role, of course. From tainted tomatoes to melamine-laced dog food, Americans expect their purchases to be safe. If storms wipe out their towns, they expect government help to rebuild them bigger and better than ever-even if that only gives Mother Nature a fatter target the next time. We want government to protect our airplanes and infrastructure from terrorists.

The financial meltdown has accelerated our expectations that government will keep us safe. And it has brought public officials directly into the big decisions about who wins and loses in the markets. We've gone from debates over privatizing the public sector to big steps toward governmentalizing the private sector. We're writing this new social contract with three guides: more public money in the private economy, more rules to shape how the private sector behaves, and more citizen expectations that govern-ment will manage the risks we face. The problem? We're making it up as we go along, and we're not sure where we're going.

No Exit Strategy

Barack Obama ran as the candidate of "change we can believe in." Because of the financial crisis, change is inevitable and epic. We've drifted into a new brand of government-directed capitalism, in which "neither Adam Smith nor John Maynard Keynes, neither Joseph Schumpeter nor today's econometricians, give one a clue about how to track, temper or tame it," University of Pennsylvania political scientist John DiIulio concludes. In just a few months, we've gone from debating toxic mortgages to pushing the government into direct decisions about capital flows and subsidies to big financial institutions in which the government now has a substantial ownership stake.

So far, corporations have resisted pressures to unload their private jets and divulge their market decisions. When pressed about what JPMorgan Chase did with federal bailout money, a spokesman said, "We have not disclosed that to the public. We're declining to." That position, echoed by 20 other banks that received more than $1 billion each from the government, leaves federal officials with two options: Shovel out hundreds of billions of dollars and hope for the best, or view the bailout money as an investment-expecting certain results and insisting on openness about how the money is being used. Both the Obama administration and Congress have made clear they reject the first position and will insist on the second.

But even if that's the case, how will they make the system of accountability work? We know we want to get out quickly, but we haven't charted the path. In the debate over a potential bailout for automakers, one federal official asked a congressional staffer about how the government's proposed oversight would function. "We're too busy to worry about that now," was the reply.

Three Puzzles

The war in Iraq shows the dangers of jumping in with the hope of a quick, surgical win but without a plan to get out. The broader and deeper the financial rescue gets, the longer the federal government's role is likely to last and the more money will be at risk. If we care about making the rescue work-if we care about making our entire system of government work-we can't be too busy to worry about these issues. Three big puzzles loom.

First, we're inventing new tools on the fly and we haven't figured out how to use them. For the last half of the last century, the government expanded most of its programs through indirect proxy tools: contracts, grants, regulations, loan programs and tax incentives. We created programs to provide nursing home care and clean the environment, to fund health care for seniors and subsidize home mortgages, to support local schools and create sophisticated military technology, to go to the moon and make airlines safer.

Now government has directly grabbed the wheel. We're telling banks what kind of investments they can make. We're imposing new expectations on the auto industry in exchange for financial transfusions. We're layering government by bailout on top of government by proxy, and we're not doing either well.

It's tempting to label this "socialism," because Karl Marx's shadow provides at least a point of reference. But in fact it's very different, with stronger reliance on market forces than Marx would have approved but a stronger government role than Adam Smith or Alexander Hamilton could have imagined.

Moreover, we're building the new direct tool on top of old ones that simply haven't worked well. The Government Accountability Office's "high-risk list" catalogs a host of current programs-most of them of the government-by-proxy variety-that are especially prone to waste and mismanagement. From the conduct of the 2010 census to contract management at agencies ranging from the Energy and Defense departments to NASA and the Federal Aviation Administration, we've seen searing examples of government's failure to update its management strategies to match its ambitious goals.

Building highly ambitious new tools on top of old ones that don't work well, and doing so without thinking about how the new ones will work, is a prescription for a multibillion- (maybe multitrillion-)dollar crisis. As we seek to reshape the way markets work, we're focusing on the nails without thinking about the hammers we'll need to drive them.

Second, our plans frame big and largely unexplored trade-offs. In Phase I of the financial bailout, economists confidently predicted we'd get almost all our money back. As Phase II geared up, however, it became clear that, at best, it will take us a long time to unwind the infusion of public cash, and we haven't thought much about how to run the process in the meantime.

Just how long will Uncle Sam hold a stake in private companies? How will government exercise its ownership role? Will federal representatives sit at board meetings? Will private plans need to pass muster with a government czar? How much public-including media-scrutiny will private companies have to accept as the price for government cash?

And that's just the beginning. How will the government balance its fiduciary interest-maximizing return to the taxpayers-with its wide-ranging social and economic goals, from protecting collective bargaining to preserving industries that market competition has punished? How will we address further market failures? How will we set priorities for which businesses to save, and who will make these calls? Fannie Mae and Freddie Mac, for example, are required to pay a 10 percent divi- dend on the money the Treasury invested to prop them up. Does the goal of maximizing the return to taxpayers increase the risk the companies will fail?

We're not very good at asking, let alone answering, such questions. We're likely to carom along from issue to issue, without confronting the big puzzles until the implications begin to accumulate. We'll probably slide sideways into a whole new understanding of whom government will help and how it will act. That frames the third puzzle: whether our public institutions have the capacity to act effectively in a world where all important problems are global and where international markets swiftly punish fumbles. In Phase I, the Fed and the Treasury made the key decisions with relatively little oversight. Will Congress continue to allow a White House-Treasury-Fed triumvirate to strip the legislative branch of any real role in some of the most important decisions the country has ever faced? After Congress' struggle to move on the first stage of the rescue, the bailout of the car companies, and an economic stimulus package, can it deliberate but still govern?

Then there's the issue of who runs the daily operations. Should we concentrate administrative power in a czar? The history of federal czars-for drugs, homeland security and faith-based programs-is not a happy one. Should we move instead to a multimember board to avoid centering too much power on a single official? Should we put the power in the Treasury, where political pressures could be greater, or in a Fed-like independent agency, where political responsiveness might be less?

The Next Government

The answers to these questions stretch far beyond our experience, but two things are certain. First, since we're going to be in this for a long time, we need to sort out the governance issues upfront before we drift into game-changing economic decisions without political accountability. Second, if we're uncertain about the right answers, we should put a big marker on transparency. We're reinventing accountability on the fly, so the more we know about what's going on, the better we'll be able to figure out what institutional and procedural reforms we need.

If history is a guide, once we jump in, we're unlikely to back out when the economy recovers. In 1979's Chrysler bailout and the savings and loan rescue of the early 1990s, the government got in and out relatively quickly. But the responses to the really big crises-such as the economic recovery programs of the New Deal, the World War II mobilization, the strategies of the Cold War, and the creation of a homeland security apparatus after Sept. 11-teach us once we advance government's power, we tend not to roll it back. So we're not just figuring out how to get through the next four months or the next four years. In all likelihood, we're also permanently redefining the social contract between citizens and their government.

Trying to run a 21st century government with clumsy 20th century tactics is a prescription for disaster. But that doesn't have to happen. We can begin by recognizing that big plans are worthless unless there's an effective strategy to carry them out. We can follow by understanding that in such a fluid environment, we need to create a foundation of trust and accountability for what we're doing. Follow the money and we'll have some sense of where we're taking ourselves.

The story is hopeful if we're smart. At each of the big turning points throughout American history, we've found a way to step up to the challenges we face. What we now need is the next government of the United States, one that is nimble enough to tackle the challenges we're facing, smart enough to steer well through the new crises and clever enough to stay half a step ahead of the strategies it is creating.

Donald F. Kettl is Robert A. Fox Leadership Professor at the University of Pennsylvania and a fellow at the National Academy of Public Administration. He is author of The Next Government of the United States: Why Our Institutions Fail Us and How to Fix Them (W.W. Norton, 2009).