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.

A great overview of the crisis by guests on Freakonomics blog

Doug Diamond and Anil Kashyap penned a very thoughtful overview of the financial crisis, where probably the most interesting part is the analysis. The Fed arguably made the right move by not addressing the credit crunch with a (further) lowered federal funds rate, but by some underwriting, a.k.a. bailing out. But what precedents does that set, and what implications are there for behavior of firms like A.I.G. that are far from the Fed's typically regulated client?

Then, it was railroads, not subprime mortgages

I was reading Gotham last night and almost did a double-take after reading the beginning of Chapter 58, which discusses the financial crises of 1873, on which Wikipedia also has a page.

So many aspects of the current financial crisis have counterparts in past crises, this one in particular. That is to say, financial crises are certainly not new. The sad part is that despite all this knowledge, we seem to have remained powerless to stop them.

The collapse in railroad stocks led to a general banking panic and a multi-year recession. Here's a quote from the book (page 1021) attributed to Cornelius Vanderbilt, where if you just replace "railroads" with "subprime mortgages," you'd describe the current situation quite well:

"There are," he argued, "many worthless railroads started in this country without any means to carry them through." To raise money, entrepreneurs had turned to "respectable banking houses in New York, so called," who affixed them with "a kind of moral guarantee of their secureness" and sold the bonds in Europe. But the roads, many of which went "from nowhere to nowhere," soon got into difficulties. "If people will carry on business in this madcap manner," he concluded, "they must run amuck."

Sound off about SmartWork

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The team at Norton has spent many long hours designing SmartWork, and many aspects of the program work well.

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