The bailout and perspectives toward risk

When writing about who will pay for the bailout package, Paul Krugman wrote something about something subtle. Not the canard of Chinese financing, which I think people asked him about. Yes, China has financed our twin deficits in the current account and on government balance sheets, but the bailout represents something different than more government spending unfunded by tax increases.

It's risk sharing. When the government buys troubled assets or businesses, it is implicitly making the American public hold risk that previously was privately held. There may also be a subsidy involved, but to the extent the assets retain an uncertain value, we're talking about the assumption of risk.

On its own, this creates bad incentives for those private firms and individuals who originally took on the risk and got bailed out. But when all private savers become scared and uniformly decrease their risk exposure, as is currently happening, every business and individual with "risky" debt --- even credit card balances, basically anything that isn't a U.S. government security --- suffers. Then businesses' employees suffer when they get laid off. Then we all suffer.

One could argue that an (i.e., not the only) appropriate action of government in such times is exactly to take on more risk publicly, when it is newly being avoided by private agents, if we view the latter as suboptimal risk holding engendered by irrational fear. (If we think it's rational, that's another story. But do we think recessions are rational? That's a huge can of worms.)

Still, to many it's the rewarding of negligent risk-taking to which people object. Folks on the left and the right in the House despised the idea of bailing out people who "should have known better."

Stepping away from the financial crisis, does this sound at all familiar? In fact, we have a long history of disagreeing about public assumption of private risk in the U.S.

In another form, it is the debate over public health insurance.

Many of the same people who are upset about publicly assuming risk in the bailout are the same folks who are upset about publicly insuring citizens against risks to health. Not everyone, mind you; the left typically favors such moves, while they do not like the bailout.

And it would be wrong to suggest the two types of risk are more than just a little similar. But some of our nation's core beliefs, about individual responsibility and the scope of government, clearly affect perceptions toward both issues.

Best title ever

Perspectives offered by Robert Shiller are titled most appropriately. Shiller provides a long-term perspective on the lessons of the current financial crisis.

You know you're in trouble when

the far right and the far left work to defeat something the center supports. Although the roll call on the 228-205 House vote that set back the bailout is still unavailable, one suspects it's the forces of the free-marketers on the right and the populists on the left (and the right) joining together to bring it down. Score one for the wings!

My two cents

A friend asked me my thoughts about the bailout package, and I wrote an email book. Then it occurred to me I could post it!

With an extraordinarily complicated problem, it's difficult to express anything in a not-complicated kind of way, or even to come down firmly on one side or another.

But if prodded, I think I come down more firmly than many economists on the side of pro-bailout. It's not crystal clear exactly how deep the problems go with banks and other financial institutions, but I think it's likely right that the nation is facing a once-in-a-century type of financial crisis --- that demands public intervention.

The main argument against the Paulson plan is that it will put taxpayers' money on the line without necessarily undoing or rooting out the bad choices that got us into this mess. I think that's right, but I also think that can be done later, once the crisis has passed. Quickly cutting out the dead wood requires either public ownership of firms, which Republicans would never agree to, or allowing firms to fail, which would destroy the ability of banks to lend to anyone, a collapse of financial markets altogether. Many of us would lose our jobs, and although it wouldn't be permanent, it would be far more costly and painful than lending about $2,333 per person ($700 billion spread over 300 million people) to the markets via the Treasury --- money that we could be paid back, although it's uncertain.

What's been interesting to me is that academic economists have been deeply split on the bailout plan, because it has included basically no structural details. Economists hate the idea of throwing good money after bad, of not structuring something optimally. I'm leery of it too, but I'm dubious that this is the right time to be arguing over details.

The form of the bailout

The price tag of the $700 billion rescue package currently before Congress is generating much interest regarding the conditions of the bailout. The Times's Paul Krugman is just one of the more vociferous advocates, certainly not the only one, of a realignment of the terms toward public ownership of financial institutions, not purchase of their questionably valued assets.

If recent history in Sweden serves as any guide, it certainly suggests public ownership is a feasible solution, at least for a country whose GDP is only about 2% of U.S. GDP and is thus considerably smaller relative to the entire market.

Traditionally, the Republican Party has been relatively more opposed public ownership of market participants, and certainly in normal times such opposition makes a lot of sense. Given the topsy-turvy state of political views about this, however, it is far from clear who, if anyone, may stand in the way of such a move, if it were ever formally suggested. Per Krugman, apparently Christopher Dodd has introduced a competing bill with such provisions.

Why we bail out: Slides on banks and panics

I wrote up a set of slides on the financial crisis of 2008 for my undergraduate macroeconomics class at Queens College this term.

We do we bail out insurance groups and investment banks who bet unwisely? After all, it's our money, right? Read on.

Heady days

The announcement by the U.S. Treasury today that mutual funds can pay a fee to be federally insured against losses for a year is a clear sign of the breadth of the financial crisis.

I have to admit, I started thinking this week about whether to yank my money out of a mutual fund and into an FDIC-insured bank account. Thanks, New York Times! I suppose it could be seen as ironic, but really it's revealing: the Treasury made this move precisely because people like you and I are thinking about doing just that.