Thursday, September 25, 2008

Bailouts, Let's Trust the Experts

The regular response I've heard on the $700 billion bailout is that the issue is too complicated and that that we have to trust our politicians to get informed and make the right decision. Instead, I suggest we turn our trust over to the experts of the economy, not the experts of reelection.

Quoted by Greg Mankiw:
"The decisions that will be made this weekend matter not just to the prospects of the U.S. economy in the year to come; they will shape the type of capitalism we will live in for the next fifty years. Do we want to live in a system where profits are private, but losses are socialized?"

Said by Arnold Kling:
"Today, it is clear that the U.S. financial sector needs to shrink. As another one of your [he is talking to Ben Bernanke] former classmates, Ken Rogoff, has pointed out, the financial sector has accounted for an unusually large share of corporate profits in recent years. It is time for this country to shift talent and capital elsewhere. In order for that to happen, some firms in the industry need to tighten their belts, some weaker firms need to merge with stronger firms, and the weakest firms need to fail. As tempting as it is to intervene in this process to try to make it more orderly, dislocation is inevitable, and intervention may only make it worse. We have excesses. Too many housing units. Too many "homeowners" who don't have equity in their homes and never did. Too many banks and financial institutions. The excesses need to be worked out by the markets."

Posted by Naked Capitalism:
"First, let's focus on the aspect that should get the proposal dinged (or renegotiated) regardless of any possible merit, namely, that it gives the Treasury imperial power with respect to a simply huge amount of funds. $700 billion is comparable to the hard cost of the Iraq war, bigger than the annual Pentagon budget. And mind you, $700 billion is not the maximum that the Treasury may spend, it's the ceiling on the outstandings at any one time. It's a balance sheet number, not an expenditure limit."

Said by Arnold Kling:
"1) Today's economy differs from that of the 1930's. Then, it may be that the financial sector may have contributed to the downturn elsewhere. Today, the financial sector is the downturn. 2) The bailout blends finance with government. It is the Fannie Mae and Freddie Mac model, writ large. As we saw with Freddie and Fannie, when you blend finance with government, the firms have an incentive to manipulate the government and government has an incentive to meddle with the firm. 3) Trying to tweak the bailout to try to redistribute the pains and gains so that taxpayers come out better and shareholders/executives come out worse is beside the point. If you put lipstick on a pig, it's still a pig. 4) The housing market is out of balance, in part due to excess home borrowing. Until it is in balance, no one will know what mortgage securities are worth. Attempts to prop up home borrowing, by freezing foreclosures for example, are counterproductive."

Said by Bryan Caplan:
"My conjecture: If Paulson's bail-out were funded by a permanent tax increase sufficient to raise $700B in present value terms, it wouldn't stand a chance. The minimal public outcry, therefore, hinges on "debt illusion" - the mistaken view that debts, unlike taxes, never really have to be paid."

A petition signed by over 100 economists:
"As economists, we want to express to Congress our great concern for the plan proposed by Treasury Secretary Paulson to deal with the financial crisis. We are well aware of the difficulty of the current financial situation and we agree with the need for bold action to ensure that the financial system continues to function. We see three fatal pitfalls in the currently proposed plan:

1) Its fairness. The plan is a subsidy to investors at taxpayers’ expense. Investors who took risks to earn profits must also bear the losses. Not every business failure carries systemic risk. The government can ensure a well-functioning financial industry, able to make new loans to creditworthy borrowers, without bailing out particular investors and institutions whose choices proved unwise. 2) Its ambiguity. Neither the mission of the new agency nor its oversight are clear. If taxpayers are to buy illiquid and opaque assets from troubled sellers, the terms, occasions, and methods of such purchases must be crystal clear ahead of time and carefully monitored afterwards. 3) Its long-term effects. If the plan is enacted, its effects will be with us for a generation. For all their recent troubles, America's dynamic and innovative private capital markets have brought the nation unparalleled prosperity. Fundamentally weakening those markets in order to calm short-run disruptions is desperately short-sighted.

For these reasons we ask Congress not to rush, to hold appropriate hearings, and to carefully consider the right course of action, and to wisely determine the future of the financial industry and the U.S. economy for years to come."

Also, here a long series of economists asked the same three questions:
1. How bad is the current market situation?
2. How bad are the current proposed bailout plans?
3. What's the one thing we should be doing that we're not?

If you're not skeptical yet, here is a quote from the actual proposal: "Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency."


  1. Not saying I disagree (because I don't know enough to), but to play devil's advocate:

    -Warren Buffet disagrees.
    -Paulson and Bernanke are not elected. In fact, Paulson will be gone in four months.
    -The quote at the end was in Paulson's original 3-page plan. Congress has filled that with restrictions so that it's now up to 102 pages and counting.

  2. This could be a reason Buffet supports the bailout:

    I'm not sure if I can trust Paulson. He said this on March 17th, 2008:
    "Our economy has ups and downs. The long-term fundamentals -- and I'm very confident about this. When we look at our long-term fundamentals compared with other major countries around the world, we have strong long-term fundamentals. That will be reflected in our currency markets."

    As for Bernanke, Harvard economist Greg Mankiw would like to sit down and chat, but at the end of the day would trust him:

  3. Brad Jones7:22 PM

    This blog is flippin sweet. And I was pretty pumped to see the bailout fail today. I was watching some Ron Paul video of him during the House of Reps discussion, they must really hate him. You gonna vote Chuck Baldwin, Harrison?

  4. Thanks Brad. I'm still unsure about the bailout, although I'm pretty sure it's not the solution. I think we're going to have to endure a little slow or no growth, but that it would be good to readjustment.

    Ron Paul rocks. That has been my favorite vote I've ever cast.

    I'm actually still undecided and haven't looked in detail at the Constitution Party (or even the details of the Libertarian Party), but I have a feeling I might be "wasting my vote" this season.

  5. Brad Jones7:22 PM

    New Ron Paul quote for you. I thought this was especially interesting:

    "As with many other government proposals, the opportunity cost of this bailout goes unmentioned. $700 billion tied up in illiquid assets is $700 billion that is not put to productive use. That amount of money in the private sector could be used to research new technologies, start small business that create thousands of jobs, or upgrade vital infrastructure. Instead, that money will be siphoned off into unproductive assets which may burden the government for years to come. The great French economist Frederic Bastiat is famous for explaining the difference between what is seen and what is unseen. In this case the bailout’s proponents see the alleged benefits, while they fail to see the jobs, businesses, and technologies not created due to this utter waste of money."

  6. Great quote!

    Here are some cheaper solutions that seem feasible:

    1) Reduce the capital requirements

    2) Get rid of the "mark to market accounting" procedure

    3) Hold your breath

  7. Ok, now I disagree. I'm really not sure what that guy's open, obviously fake bet has to do with anything. I think Warren Buffet has a lot more in this (to the tune of oh, $5 Billion he spent last week) than that.

    My point is there are smart people on both sides of this thing, not just "the experts of reelection" (of which Paulson and Bernanke are not, regardless of whether we trust them).

    At this point I'm much more inclined to take the risk spending the money to avoid your friend's worse case scenario ( I guess what I'm saying is it's not all black and white... :)

  8. My fear is that we are being scared into unconstitutionally passing huge amounts of power over to federal government. I'm willing to accept some slow or even reversed economic growth to ensure American capitalism survives.


You are the reason why I do not write privately. I would love to hear your thoughts, whether you agree or not.