Reform in the age of the primal screen

President Obama’s new proposals for financial regulation sound like a big mea culpa, not for anything he did, but for the excesses of the past decade that helped lead 65 percent of the world’s countries into recession.

His speech this week could not have come at a more critical time, as the U.S. and the world stand poised at the crossroads of recovery. The global financial system has largely been stabilized. Yet, the dramatic and disorderly process of rescuing the system upset consumers who lost confidence in their leaders and institutions. Now, if consumers who still have jobs don’t loosen their wallets, at least a little, the recession is going to get a lot worse and last a lot longer.

How to get people spending again is a vexing problem for the administration. Americans are hurting after a battering of bankruptcies and foreclosures. In May, 9.4 percent were unemployed. Consumers are scared. This is one reason why President Obama wants to establish the Consumer Financial Protection Agency. “This agency will have the power to set standards so that companies compete by offering innovative products that consumers actually want — and actually understand,” he said. “Those ridiculous contracts with pages of fine print that no one can figure out — those things will be a thing of the past.”

Consumers need to believe that government is going to look out for them. They realized that they were last on the help list back in October as then-Secretary of the Treasury Henry Paulson first demanded an unprecedented amount of cash to save the banks. Viewers watched Paulson’s worried expression as he described the need for intervention. Members of Congress, whom he prodded to act quickly, appeared flummoxed and disoriented. The fear in their voices and their collective angst over their ability to stop a global financial meltdown radiated through television and computer screens across the globe.

In the Screen Age, this emotional contagion could spread instantly to a Berlin shopper watching on his cell phone, to hotel guests eyeing a flat screen in an elevator in Denver, to a family watching television in Beijing, or to airline passengers viewing screens high over the Andes.

Emotional contagion is the phenomenon of catching other people’s emotions. Sigal Barsade, a professor of management at the Wharton School at the University of Pennsylvania, has written extensively about it and described how it works. “You see people fearful around you, and it triggers something cognitively in you that says, ‘Wow, even though there is nothing wrong with me right now, if all these people are so afraid, maybe something will happen, and I should cut back spending,’” she said. “But the cognitive aspect is just a small piece of it. It is also an automatic process. We don’t realize it is happening.”

A fear contagion can cause people to overcorrect, taking extreme actions whose adverse effects ripple in waves through the rest of society. Last fall, before the massive layoffs began, U.S. consumers stopped spending. According to the Rockefeller Institute, state tax collections in the fourth quarter of 2008 declined four percent from the previous year, the worst in 50 years.

A December 2008 report by the International Monetary Fund warned that the strong fall in aggregate demand “could be larger than in any period since the Great Depression.”

Early government stimulus measures in the form of reduced personal taxes and increased social benefits have not buoyed the economy. According to the Bureau of Economic Research, personal disposable income rose in March and April, but personal consumption decreased in both months. Researchers concluded that consumers have been saving the difference. Personal saving was 4.5 percent of after tax income in March and rose to 5.7 percent in April.

As the trend toward increased savings became apparent, Masahiro Kawai of the Asian Development Bank Institute reportedly told a group of leaders that Asians themselves would now have to start consuming more. He said that they would have to rethink their old belief that “Asians make it, Americans buy it.” (In 2006, China’s personal savings rate was 28.3 percent, the highest in the world.)

It’s clear that Paulson’s insistence on intervention prompted other governments to prop up their banks as well and together they prevented a full financial meltdown. Ten of the largest U.S. banks have now repaid $68 billion of their TARP money. Unfortunately, a few of the too big to fail banks have only become bigger as they absorbed failed institutions.

Obama’s new proposal seeks to prevent such disorder in the future by giving the Federal Reserve expanded powers to regulate bank holding companies, to oversee AIG-like organizations and “all large, interconnected firms whose failure could threaten the stability of the system.”

Still, the messy and improvised process may have created a lasting sense of wariness and mistrust among consumers toward the industry. Americans do need to save more, but they don’t need to do it all at once. In order to get people to save a little and spend a little, the administration will have to devote great effort to both defeating the entrenched interests that want to revert to business as usual, while persuading the public that being stingy could be harmful to their long term prospects, worsening both the consumer crisis this year and the commercial crisis that is anticipated next year.

Susan E. Reed has covered business and international affairs for CBS News, The New York Times, The New Republic and other news organizations.