By Menzie Chinn
Or, who will be the Keating 5 of the 2000’s? Perspectives from those of us who remember the East Asian crises of the 1990’s.
From the NYT:
News Analysis
A ‘Moral Hazard’ for a Housing Bailout: Sorting the Victims From Those Who Volunteered
By EDMUND L. ANDREWS
Published: February 23, 2008
WASHINGTON — Over the last two decades, few industries have lobbied more ferociously or effectively than banks to get the government out of its business and to obtain freer rein for “financial innovation.”
But as losses from bad mortgages and mortgage-backed securities climb past $200 billion, talk among banking executives for an epic government rescue plan is suddenly coming into fashion.
A confidential proposal that Bank of America circulated to members of Congress this month provides a stunning glimpse of how quickly the industry has reversed its laissez-faire disdain for second-guessing by the government — now that it is in trouble.
The proposal warns that up to $739 billion in mortgages are at “moderate to high risk” of defaulting over the next five years and that millions of families could lose their homes.
To prevent that, Bank of America suggested creating a Federal Homeowner Preservation Corporation that would buy up billions of dollars in troubled mortgages at a deep discount, forgive debt above the current market value of the homes and use federal loan guarantees to refinance the borrowers at lower rates.
“We believe that any intervention by the federal government will be acceptable only if it is not perceived as a bailout of the bond market,” the financial institution noted.
In practice, taxpayers would almost certainly view such a move as a bailout. If lawmakers and the Bush administration agreed to this step, it could be on a scale similar to the government’s $200 billion bailout of the savings and loan industry in the 1990s. The arguments against a bailout are powerful. It would mostly benefit banks and Wall Street firms that earned huge fees by packaging trillions of dollars in risky mortgages, often without documenting the incomes of borrowers and often turning a blind eye to clear fraud by borrowers or mortgage brokers.
A rescue would also create a “moral hazard,” many experts contend, by encouraging banks and home buyers to take outsize risks in the future, in the expectation of another government bailout if things go wrong again.
If the government pays too much for the mortgages or the market declines even more than it has already, Washington — read, taxpayers — could be stuck with hundreds of billions of dollars in defaulted loans.
But a growing number of policy makers and community advocacy activists argue that a government rescue may nonetheless be the most sensible way to avoid a broader disruption of the entire economy.
…
One paragraph in the article I find quite amusing is this one:
Surprisingly, the normally free-market Bush administration has expressed interest. Treasury officials confirmed that several senior officials invited Mr. Taylor to present his ideas to them on Feb. 15. Mr. Taylor said he had also received calls from officials at the Office of Thrift Supervision and the Office of the Comptroller of the Currency, which is part of the Treasury Department.
To me, it is completely unsurprising that the Administration should be willing to bail out financial institutions. They are well connected in the way that the unemployed [1] or the uninsured [2] are not.
However, this is not a rationale for not intervening. As I’ve said before, “Just say ‘no'” is not a viable policy. The key point is to realize that, just like some of the East Asian economies in 1997, we are well past the point about worrying about the impact of current policies on “moral hazard” (see this analysis [pdf]). We needed prudential regulation in the period leading up to the housing boom (sadly, policy makers failed in that respect). That is when contingent liabilities built up (see these posts on “looting” [3], [4]). Now, it is not possible for the government to credibly commit to not intervene, when the financial system’s operation is at stake (i.e., as Krugman has said, the horse is out the barn door).
And make no mistake — the financial system is to some degree already frozen, and there is little prospect for a complete unfreezing of the system without substantial government intervention. From Deutsche Bank Economics/Strategy Weekly (Feb. 22):
…Taking MBS spreads as an example, spreads have now
widened beyond the levels reached in the convexity
episode of 2003, and is approaching the highs of the
LTCM crisis of 1998. We emphasize that it is important for
the market not to anticipate the kind of mean reversion
that occurred in those previous widening episodes. In
1998, the spread widening wasn’t a result of a systemic
problem (at least in the principal developed economies),
but rather was narrowly addressed with the unwinding of
LTCM’s positions. Spreads moved back relatively quickly
on GSE buying, as GSE’s then were a reasonably large
part of the mortgage market at that time, unlike the
current moment, when the GSE’s have been and are still
hampered by regulatory and competitive restrictions, and
thus are too small to serve as a stabilizing force.
In this sense, the current crisis is very much like the S&L crisis. And as it looks more and more likely that the government will have to spend billions of dollars bailing out investors, banks, and households, it seems to me that accountability is required. Who in the Administration pushed to prevent regulatory oversight? Who in Congress pushed the interests of the banks?
And we should look very carefully at the proposals that are being pushed by the financial industry, even as we acknowledge that laissez faire is not tenable, and we seek to establish procedures and institutional reforms that will prevent a replay. In particular, thinking about a well-funded, integrated, regulatory system that is insulated from political pressures would be a good place to start.
This post was by Menzie Chinn
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I’m ready to sign on to a bank bailout as soon as we slap a 100% tax on all banker incomes above a generous $100,000 a year, more than twice the median income. After all, the bankers were very successful in pushing through bankruptcy reform in 2005 to keep consumers from defaulting. Likewise shouldn’t we squeeze the people responsible for this debacle to pay for their own bailout. Why should guys like Charles Prince and Stan O’Neal be able to just walk away with hundreds of millions of taxpayer bailout money?
More seriously, how about public ownership equity in exchange for a bailout. It seems to work for Britain. Why should some guy from Abu Dhabi get an equity stake for his bailout of Citigroup and U.S. citizens get nothing?
Or how about a whopping increase in the corporate tax on financial institutions? Something like 40% of all U.S. company profits in recent years have been in the financial sector. This seems to be a perversion of the economy and maybe we need to discourage its growth.
There is a lot of rubbish being written, by people who should know better, about empty barns, water under the bridge, no point being fundamentalist etc. The moral hazard that really matters is not institutional, but macro and cultural, and the outcome of the current test has yet to be decided. All the central bankers’ tricks like commitment technology, fiddling inflation, risk management, targeting forecast inflation etc have been used up. Only now, when the inflation constraint is binding, does the policymakers’ choice really matter.
Truly an intellectually lacking article. Unfortunately this is what is considered intelligence in today’s society. Scary to think this man is teaching economic students this garbage. This is not an article about a bailout, it is an article supporting socialism, every sentence drips for contempt for the capitalist system that has made this the greatest country in the world.
The problem with our system is not that it is broken, it is that the government, charged with protecting its citizens, does nothing of that nature. People who do wrong need to be punished severly, not saved by those who work hard for their money. Protectin citizens is punishing those who do wrong, not rewarding those who do wrong or make lousy choices.
How can anyone take any economic analysis seriously when the author quotes Paul Krugman who has spent eight years being consistly wrong on everything. I have a monkey that has more economic sense than him. Krugman is not an economist, he is a politicial hack, just by reading him and quoting him we know where this article comes from. I am sure Marx could teach economics at Princeton or UCSD but that would not make his ideas right, reality has already proved him wrong.
For some reasons people like Mr. Hamilton make excuse after excuse for why socialism fails in every attempt (other than of course killing 100 million people) but the greatest capitalism system that created the greatest country in the world is a failure becuase there are poor people. Well a system with 5% poor (most of which are lazy dumb people who make bad choices) is better than a system where everyone except the rulers are poor.
And who the hell mentions the Keating 5 after all these years. I wonder if the author has the NY Slimes article about McCain on his mind? As for the insinuation that the financial industry owns the current administration and the poor and uninsured have no contacts, last time I checked every wall street loser was lining up behind Hillbama. And what do the uninsured have to do with the housing crisis. You bought a house you could not afford so that has something to do with your health insurance?
As for the points. “Even as we acknowledge that laissez faire is not tenable.” Who acknowledged that? It is certainly untenable when our first reaction to things is to have the government come bail us out and then figure out what regulations can be put in place for the future. Which is a great idea, becuase when we put more regulations on the economy we will undoubtedly have fewer bribes paid by the banks to politicians to have those regulations help the bankers. Regulation stifles competition, so established institutions do not mind them that much. I wonder why it costs hundreds of millions of dollars to take a company public, could it have something to do with the lack of competition?
How about this idea. The banks who allowed this to happen out of sheer greed go under. The bankers who made tens of millions of dollars over the last five years creating these products get sued by the banks so that they have to return their enormous bonuses they stole from the American public (I personally would like to seem them punished a little more physicaly by the people who they screwed over, but violence is never the answer). The people who made bad decisions and bought homes they could not afford get kicked out on the streets. I keep my money that I worked hard for, creating my own company, sleeping on a floor and not buying a thing for myself for two years.
Where is it right that the responsible people in this country have to pay for others’ mistakes? How in the world is this not going to happen again? Oh, new regulations! Do you think next time the bankers will steal money the same way? Every ten years they find a new way to rip off the American public.
All my sympathies to anyone who has to pay to learn economics from this intellectual light weight.
Peter: The intellectual light weight you mention is Menzie Chinn, not James Hamilton. Jim is absolved of any responsibility for this post.
By the way, I’ve been thinking about the Keating 5 for a long time, since I teach money and banking, and the S&L crisis is a canonical example.
With a little less vitriol, I’d also ask the question ‘who says laissez faire isn’t tenable?’ I can see some worthwhile efforts at the fringes, like easing accounting rules to improve trustee abilities to do loss-mitigation workouts, but for the most part I don’t see the need for an intervention, and the talk of an intervention may be a large part of what’s make the situation so bad.
People don’t end up in the streets after a foreclosure. If they have a job, they end up in rental housing. Why is that so awful? There will be huge losses in CDS and other derivative markets. So what, those are two sided markets and someone else, smart enough to figure out the situation, bet right and should make a bundle. Why should capitalists who bet right be made to lose to capitalists who bet wrong? Maybe a couple of big banks who made stupid bets will need to be restructured, but the big banks are all well capitalized, so I don’t see much risk to the FDIC from that (note, I think the FDIC will take some hits from a lot of weak, small institutions, but it won’t add up to a lot).
Markets are seized up and spreads are wide. That will divert capital from markets, like housing, where returns are uncertain to other markets where they are more certain. Isn’t that how this system is supposed to work? And just maybe the reason that no one is selling, causing spreads to be high, is the uncertainty surrounding bail-out proposals. How stupid would you look if you sold your portfolio for 70% of par and a month later the government was buying similar stuff for 85% of par?
Mortgage Crisis and Bailing Out The Bankers
Over at Econbrowser we find an interesting article about “crony capitalism” and a potential bailout for the bankers. It underscores some key points that highlight why I remain extremely cautious on the mortgage and real estate markets. …
And I’m with Joseph on the equity stake idea. While I don’t think a bail out is necessary, if there is to be one it should come with a requirement that no one can sell to this bail-out entity unless they first provide a meaningful equity stake to the government. This requirement was put in for the airline bailout after Sept. 11, and a lot of airlines lost interest in the bail-out once that requirement was put into place.
Money markets are seized up because they are waiting for the Government bailout. What if the Government declares that there will be no intervention? Most banks will collapse and a new system will emerge in no time. Let take a deep breath and decide not to subsidize unmanageable, losing, “hopeless” industries (Britain let coal mines to close down and see, the world did not end).
By unmanageable I meant corrupt.
Menzie,
The S&L crisis did not involve a “bail out of investors, banks and households.” The FSLIC, FDIC and RTC together merely made good on a preexisting contract: deposit insurance.
As for the triumvirate of the “bailed out” that you mention: banks and thrifts were not “bailed out” as they forfeited their capital; investors in commercial real estate were not “bailed out” as they suffered losses due to the RTC’s dumping of collateral; and finally households were not “bailed out” as they lost their condo’s to foreclosure.
As for “just say no” being non-viable: did you think the same when the U.S., via the IMF, consistently advised Asian and Latin American countries in the 90’s to forego publicly financed bail outs, to avoid negative real interest rates, and to keep government finances in the black? Clearly, this series of measures was thought to be viable by the “Washington Consensus” of the time.
@ Peter; might I suggest that this capitalist financial crisis isn’t perhaps the best example of what’s so wrong with socialism?
Such a bail out scheme sounds to me very much like the UK government’s rescue of Northern Rock, a smallish bank by British standards, but one which sought to avoid the common stereotype of bankers as staid conservative people, by relying almost entirely on the financial markets to fund its mortgages. On the back of this model, hailed as the best thing since sliced bread as recently as Spring 07 it managed to get 20% of the UK mortgage market.
When the source of those funds dried up in the middle of 2007, it effectively went bust – its mortgages first underwritten by the Bank of England and then nationalised in January 2008.
The Financial Times commenting on this measure noted that; Anybody who suggests that the Labour government has gone back to 1970s socialism deserves ridicule.
If people do want to read a socialist take on it then try here;
http://www.permanentrevolution.net/?view=entry&entry=1928
j: Then I take it you are in favor of letting the banking system collapse, and interbank borrowing spreads (as well as those on other asset-backed securities) rising impediment, as long as that is the outcome of letting the market work through without government intervention? Merely a point of clarification — although I think the equation of coal mining and finance unpersuasive.
David Pearson: Is it your assertion, then, there was absolutely no implicit subsidy component to bank capital owners and to commercial real estate owners? That the only beneficiaries of the hundreds of billions of dollars of taxpayer resources were depositors? The question to me is whether the bank capital owners and commercial real estate owners bore the full cost of their actions.
With respect to your third question, my answer is “no”. Please see the article linked to in the post (Chinn, Dooley, Shrestha, JIMF, 1999).
Market economies work better than command economies because incompetently run firms go out of business and are replace by competently run competitors, and individuals who make bad investment decisions lose money to people who make good decisions.
It’s quite clear that a substantial fraction of the managers in the financial industry are competent only at defrauding investors.
We really, really need for these people to go out of business.
Continued subsidy of incompetence and fraudulent behavior threatens the very survival of our nation.
It seems we have a ‘consensus’ albeit one arrived at through varied lines of reasoning.
The hazard here is setting a ‘floor’ under an overpriced housing market by ‘subsidizing’ the folks who bought in at inflated prices.
While this will staunch some of the blood flowing from the CDO markets, it will come at the expense of prolonging the housing correction.
Which, in my opinion, still has a long way to go given how the real problem in not a credit crisis butt one of insolvency.
Let the banks fail, Prof. Chinn, any and all of them.
So, we have to return to small, local banks, where depositors watch their funds like a hawk and bankers make local loans. Worked well enough for us for our first 150 years.
Privately issued currency worked, too.
Menzie,
My assertion stands: the three groups you mentioned were not “bailed out” in the course of paying out depositors from the deposit insurance fund(s).
To clarify: I am referring to the period after FIRREA was passed in 1989. Before that there were numerous attempts at bailing out specific entities and relaxing regulatory oversight. FIRREA was, in part, the result of a political backlash against the fiscal cost of those attempts. The consensus was not to attempt to delay adjustments in commercial real estate prices, to avert erosion of thrift or bank capital bases, or to save homeowners; it was to contain the ballooning cost of meeting the obligations of deposit insurance. This is materially different from the various proposals that are being floated today.
David Pearson: But then you concede that regulatory forbearance and so forth prior to 1989 did entail some implicit subsidy to bank capital owners, and in addition maintained commercial property prices highre then they otherwise would have been?
On a separate point, I believe the RTC’s activities of preventing a further collapse in the commercial real estate market associated with greater distress in the financial system had the effect of maintaining financial asset prices higher than they would have been in the absence of government intervention. That’s not a criticism; that’s in my view a good outcome.
How did the RTC achieve the end of maintaining higher financial asset prices? They were selling the assets of failed institutions. Not keeping the institutions afloat. But selling the assets of the failures, probably at a faster rate than if the FDIC had inherited those assets and not set up the RTC.
I guess you could argue that they more or less invented commercial MBS (not literally true, but they represented a massive expansion of that market) and the fact that this proved to be an efficient way of holding the assets led to a somewhat better price for the assets. But how much better, and why would the market not have discovered this on its own in short order? And what similar benefit would this newly (re) proposed Home Owner’s Loan Corp bring to the table, or would it just be a demander propping up the market at an artificially high price?
Menzie,
Yes, prior to FIRREA there were bail out attempts, as we know from the Keating 5 scandal. That the landmark legislation effectively reversed them just confirms that the bail out attempts had unfavorable outcomes, and that the core of the S&L crisis resolution was not a bail out. In fact, the FDIC rather arbitrarily and after-the-fact erased the favorable accounting of goodwill as capital that was granted as an incentive to early purchasers of failed thrifts.
You may be right about the RTC’s impact on CRE prices ex-post. During the crisis, however, Bill Siedman was hardly a popular figure amongst CRE investors: in fact he was regularly blamed for running roughshod, tanking prices, and otherwise being insensitive to the needs of strip mall developers and thrift shareholders. Hardly a bail out of CRE.
Lastly, a “sideshow” of the S&L crisis was the hyper-aggressive prosecution of directors, officers, lawyers and accountants of failed thrifts. Just the opposite of the “damn moral hazard, save Wall Street” mantra that we hear today.
Since ideology and the lizard brain is splashing so freely in several comments posted thus far, how about a reasoned analysis of what constitutes a “good” bailout versus a “bad” bailout?
http://www.nakedcapitalism.com/2008/02/good-bailouts-versus-bad-bailouts.html
After that, maybe, just maybe, a more serene discussion could take place on this page.
Sorry, Menzie, for all the flack your getting.
I’m still trying to connect the dots about how bailing out Wall Street investors using my tax dollars benefits me, though.
Thanks for that roundup of opinion (not exactly a “reasoned analysis”, but who’s fussy?) and that jibe at the ideological barking (still, isn’t it enough to wet your pants to see the laissez faire bankers pleading for government intervention?)[yes, we prefer seering discussion to serene views] from nakedcapitalism, Francois.
A fine post as usual Menzie, and I don’t know what to add.
My fear is the real “unwind” is the coming job dislocation and more than a few unhappy campers. Any “help” that comes should not only be “thoroughly” vetted but timely…not late for this unravelling mess.
Kevin A.: Don’t get me wrong, I don’t want a bailout. However, I think that at some point, some government funds might have to be explicitly injected (say to make a bankrupt firm attractive enough to be purchased by another firm), or implicitly (deferral of tax liabilities, or subsidies). The idea that there will be zero government assistance seems unlikely, given the magnitude of the crisis. Note that this does not mean the investors or bank capital owners are necessarily made whole; merely that they do not bear the entire loss that they would have incurred in the absence of government action. Some observers would not define this as a bailout.
I do think it likely that the only agents made whole will be the depositors.
“The idea that there will be zero government assistance seems unlikely, given the magnitude of the crisis.” Magnitude? Do you mean that some bankers may become unemployed? Let the bad banks go under, let credit be harder to get… Everyone seems to agree that Americans are living far beyond their means and need to save much more; but almost everyone seems to be struggling to make sure that they can still borrow on easy terms.
Can we agree that economists don’t really know what the future will bring? When trends are linear, they’re wonderful in their predictions; they draw a straight line. But when the trend is non-linear, as it is now, they’re completely clueless. So sure you can say that if the government does not provide assistance, there will be a serious crisis. But how can you be so sure that providing assistance will help? How do you know it’s not just throwing good money after bad? It seems to me that the one sure thing about the government providing assistance is that people who are relatively innocent in this mess will be called on to pay; while those who are relatively guilty (read investment bankers) will get off relatively easily.
Prof Chinn,
I remember from my banking and financial system course that to run a bank one must be an outstanding citizen of immaculate characters. In today’s banking world, at least in the biggest banking houses, I haven’t seen any truth to this tenet. Should we continue to save the system which by design selects and proliferates corruption, greed, cronyism,…, and other ills that society must bear? There seems to be an inherent conflict in moral and money! We think we can’t be corrupted yet have shown to be just that. So if financial realities and text book ideals aren’t the same, how can this dilemma be articulated in the class room?
…I take it you are in favor of letting the banking system collapse …
I keep my money in a bank, so I would not like it to collapse. but overprotecting the banking system is the surest way to eventually cause its collapse. It is irresponsible. … and rising interbank borrowing spreads (as well as those on other asset-backed securities)… Spreads reflect the confidence banks have in each other. A better system, lower spreads.
Is Crony Capitalism Really Returning to America?
Menzie Chinn writes in Econbrowser a very gloomy piece about the state of the US banking industry and urges a bail-out … of some kind:
As I’ve said before, “Just say ‘no’” is not a viable policy. The key point is to…
It seems most academics, including Ben Bernanke, are caught in an output gap “trap”. The logic of that trap is as follows:
-systemic banking crises lead to depressions
-we must prevent depressions
-we must have prolonged negative real interest rates
-there is no worry over inflation as long as there’s an output gap
This logic was applied in 2002, and we now have $100 oil and almost $1000 gold. It will be applied again in 2008 and 2009 because “we must save the banking system”. Fine, only please don’t kid yourself. Its likely that this decade will have sub-1% real fed funds rates 40% of the time. What will be the verdict on this policy five years from now?
this makes me continue to wonder if the “downside” of the stimulus- people might put it in the bank and save it- is actually a “downside”.
if it butresses the bank’s balance sheets it doesn’t seem that bad to me.
It’s amazing how ignorant of history some of the posters on this thread are.
In the 19th century, the banking system was virtually unregulated– and there were frequent panics, fraud, and so on. The economic damage tended to be short-lived, but that was due to the fact that the economy was largely agricultural and regionally fragmented. As the nation became larger and the scale of banking increased, the consequences of crashes became more serious and longer-lasting.
There are some truly ludicrous proposals in the comments above. One commenter imagines that the solution is to go back to local banks. How does he imagine that large-scale enterprises, running into billions of dollars, could be efficiently funded by small banks? The more likely result is that corporations would get their funding from foreign competitors.
Another poster proposes that we let the banking system collapse, since a new banking system will arise like a phoenix from the ashes “in no time.” This was tried in 1930, and after two years and the wreckage of 30% of the economy, the people grew restless at waiting for “no time” to elapse. Even with vigorous intervention, businesses that had closed “in no time” remained shuttered for a decade, and farmers displaced from their land never regained it.
There is something very wrong about an educational system that permits very ignorant people to think they have a right to be both rude and loud.
It’s early 2008 and AAA rated mortgage backed securities released as recently as last May are already at a 15% default rate. In early 2009, the default rate will be 60% at a minimum.
The Feds need to call in the CEO’s of Citi, BoA, WashMutual, Wachovia, Merrill, and the dozen or so others who participated in producing, selling, packaging, rating, this crap. They need to be told in no uncertain terms that they have limited choices:
1. Avoid corporate bankruptcy by minimizing defaults. This can be done by working with borrowers NOW to discount loans and terms to market value. Where default is inevitable, they will need to dispose of property in an orderly and efficient manner to avoid further deterioration of their assets.
2. Any institution that declares bankruptcy or needs a bailout by American taxpayers who have already been bled white by these vulture’s greed, incompetence and incomprehensibly poor business judgment will be nationalized. All executives and board members will be immediately fired. All executives and board members for the last 5 years will be required to return salaries and bonuses with interest because it’s absolutely clear that, whatever else they were doing, it sure the hell wasn’t their job. All land, buildings, contracts, and assets will become the property of the U.S. Treasury. The lawsuits alleging fraud that are beginning to be filed by the poor suckers who were last to hold the worthless securities will be allowed, but only against the individuals who perpetuated the fraud, not against the nationalized company.
If they don’t like them beans, then they can work through this mess themselves.
Charles stated –
“Another poster proposes that we let the banking system collapse, since a new banking system will arise like a phoenix from the ashes “in no time.” This was tried in 1930, and after two years and the wreckage of 30% of the economy, the people grew restless at waiting for “no time” to elapse. Even with vigorous intervention, businesses that had closed “in no time” remained shuttered for a decade, and farmers displaced from their land never regained it.”
Spot on Charles… The problem in the 30s was exacerbated by the failed economic policies of FDR.
While one can see the rationale for preserving the US economy from a crash, I find it difficult to swallow the straightforward bailout implied by the BoA proposal. Obviously, I am not alone in feeling this way. Perhaps, however, instead of buying “troubled” mortgages as suggested by BoA, which implies exchanging good money for currently worthless securities (I’m not getting into a discussion of whether they might be worth something in the future), a loan to inject liquidity into the banking system could gain support. At least taxpayers might think their children might get the money back eventually.
I’m basically thinking of something like Brady Bonds, only for banks instead of for Mexico.
Re: Spot on Charles… The problem in the 30s was exacerbated by the failed economic policies of FDR.
I doubt that Charles would extrapolate his comments to a criticism of FDR.
I can already see future revisionist historians blaming the next president for this financial crisis.
Does maintaining the current banking system necessarily mean maintaining the current crop of bankers, their investors and their creditors? Can a way be worked out to remove the incumbents, force the investors and creditors to take their lumps, yet maintain the banking system? (I don’t include federally insured depositors among those who should be forced to take the lumps.)
Don’t get me wrong, I don’t want a bailout. However, I think that at some point, some government funds might have to be explicitly injected (say to make a bankrupt firm attractive enough to be purchased by another firm), or implicitly (deferral of tax liabilities, or subsidies).
Menzie,
It is this kind of reasoning that absolutely drives me crazy. You don’t want a bail out you simply want a bail out. Or is it you don’t want a big bail out you only want a small bailout.
Do I want to see the banking system fail. Absolutely if it is so weak that it cannot survive. But this is where we differ. I absolutely believe that institutions will find ways to solve their own problems as long as the government doesn’t jump in and screw it up. I do not believe in the government has magical solutions, or that some congressman who has sold shoes all his life, or spent his life fooling juries, will know better how to resolve a banking crisis than a professional banker.
It has been pointed out that the S&L crisis became worse after the government attempted to bail it out. The only thing that worked was for the government to close and sell institutions to more stongly run institutions, but I would say that even that was a fiasco because many healthy institutions were arbitrarily closed and given to the friends of the political class.
Insanity has been defined as doing the same thing over and over expecting a different result. I would add to this that it is also expecting the same institutions that caused the problem to somehow magically solve the problem doing the same things.
Finally, to say that an injection of cash into a bankrupt firm will somehow make it more attractive is just the height of ignorance. The firm will be attractive when its assets or business prospects are greater than its costs. Injection of cash into a failing firm is like putting new icing on a moldy cake and serving it to your children.
When will we ever find economists who actually believe in economy.
Foo says, “I can already see future revisionist historians blaming the next president for this financial crisis.”
Right on this thread, Foo. When will we start caring about what happens to our country ahead of what happens to our political party?
And Babinich… perhaps you should look up the date of the election of FDR. It wasn’t 1930.
Prof. Chinn,
Lost in all these discussions of a bail out of banks and homeowners with underwater mortgages is the fact that moral hazard not only has economic and financial consequences but it also has social consequences.
At some point, the hard-working people who play by the rules, pay their taxes, are prudent with their finances, saved to buy their homes and bought homes that they could afford and had a rainy day fund to get them through unexpected rough patches are going to say that enough is enough. What if a large portion of these financially responsible people decide to say “to hell with it” because it’s not worth it to be responsible because the only people who are rewarded are those who gamble big and when they win get to keep those winnings but when they lose get to stick the hard-working taxpayer with their losses.
If a bailout occurs, I believe we will see that day. The hard-working and financially responsible taxpayer has had enough. If a bailout happens whereby the taxpayer isn’t compensated and those responsible for the mess aren’t held to account for it, including the speculators and the “jingle mail” homeowners, then there will be far larger costs than the financial costs, there will be social unrest the likes of which the country has not seen since the Great Depression. The taxpayer is tapped out and had finally had enough. This great unrest is reflected in what is happening in the Presidential primaries. The same old way of doing business is no longer acceptable to a majority of the public.
Who will have the good sense to make sure that the voices of the hard-working taxpayer are at the table in Washington when the buyout talks are held? To ignore them is to risk large-scale social unrest.
Good piece Prof. Chinn. I also admire your stiff upper lip. Inspirational.
Jon makes some good points, and may have a stronger argument than those who consistently request reductions in marginal income tax rates.
The “system” will not fail. Banks will fail. Let them go under. If there are still new people who want to borrow money and others who want to lend it, than their will be banks to do it in the future. Sheesh. Even a lot of the workerbees (not all) will keep their jobs in reorganiozed entities. Of course, shareholders and execs will take a haircut. Well that’s what equity and being the boss is all about. Let them take their haircut.