The bill being debated by Congress does not appear to be a good bill. Frankly, I do not know whether I support it. Many posters (and many economists) say the bailout is flawed or unnecessary. Yet what bothers me is the knee-jerkism of much of the liberal blogosphere.
Kos has railed against the bill, but the strongest opposition has come from OpenLeft, where David Sirota, Chris Bowers and Matt Stoller have viciously attacked the bill and its supporters (Stoller even threatening to ban supporters of the bill from the site, claiming they were being too self-righteous).
When asked about alternatives, many bring up Sweden's nationalization, while others call for directly purchasing bad mortgages or simply waiting it out for a few weeks.
They have some support from some economists. Dean Baker, who had earlier supported it, is now part of what Stoller calls the "hell no" caucus.
At this point I cannot identify a single good reason to do the bailout.
The basic argument for the bailout is that the banks are filled with so much bad debt that the banks can't trust each other to repay loans. This creates a situation in which the system of payments breaks down. That would mean that we cannot use our ATMs or credit cards or cash checks.
That is a very frightening scenario, but this is not where things end. The Federal Reserve Board would surely step in and take over the major money center banks so that the system of payments would begin functioning again. The Fed was prepared to take over the major banks back in the 80s when bad debt to developing countries threatened to make them insolvent. It is inconceivable that it has not made similar preparations in the current crisis.
In other words, the worst case scenario is that we have an extremely scary day in which the markets freeze for a few hours. Then the Fed steps in and takes over the major banks. The system of payments continues to operate exactly as before, but the bank executives are out of their jobs and the bank shareholders have likely lost most of their money. In other words, the banks have a gun pointed to their heads and are threatening to pull the trigger unless we hand them $700 billion.
For the record, the restrictions on executive pay and the commitment to give the taxpayers equity in banks in exchange for buying bad assets are jokes. These provisions are sops to provide cover. They are not written in ways to be binding. (And Congress knows how to write binding rules.)
Finally, the bailout absolutely can make things worse. We are going to be in a serious recession because of the collapse of the housing bubble. We will need effective stimulus measures to boost the economy and keep the recession from getting worse.
However, the $700 billion outlay on the bailout is likely to be used as an argument against effective stimulus. We have already seen voices like the Washington Post and the Wall Street funded Peterson Foundation arguing that the government will have to make serious cutbacks because of the bailout.
While their argument is wrong, these are powerful voices in national debates. If the bailout proves to be an obstacle to effective stimulus in future months and years, then the bailout could lead to exactly the sort of prolonged economic downturn that its proponents claim it is intended to prevent.
In short, the bailout rewards some of the richest people in the country for their incompetence. It provides little obvious economic benefit and could lead to long-term harm. That looks like a pretty bad deal.
And Nouriel Roubini of NYU says...
... the Treasury plan is a disgrace: a bailout of reckless bankers, lenders and investors that provides little direct debt relief to borrowers and financially stressed households and that will come at a very high cost to the US taxpayer. And the plan does nothing to resolve the severe stress in money markets and interbank markets that are now close to a systemic meltdown. It is pathetic that Congress did not consult any of the many professional economists that have presented - many on the RGE Monitor Finance blog forum - alternative plans that were more fair and efficient and less costly ways to resolve this crisis. This is again a case of privatizing the gains and socializing the losses; a bailout and socialism for the rich, the well-connected and Wall Street. And it is a scandal that even Congressional Democrats have fallen for this Treasury scam that does little to resolve the debt burden of millions of distressed home owners.
These are not the only progressive voices, however.
Paul Krugman has cautiously embraced the bill:
The bailout plan released yesterday is a lot better than the proposal Henry Paulson first put out — sufficiently so to be worth passing. But it’s not what you’d actually call a good plan, and it won’t end the crisis. The odds are that the next president will have to deal with some major financial emergencies.
In response to Roubini, says Krugman:
Nouriel Roubini has a characteristically scathing takedown of the Paulson plan, and here’s the thing: language aside, his economic analysis is similar to mine. The fundamental problem in the financial system is too little capital; bizarrely, the Treasury chose not to address that problem directly, by (say) purchasing preferred shares in financial institutions. Instead, the plan is premised on the belief that toxic mortgage-related waste is underpriced, and that the Treasury can recapitalize banks on the cheap by fixing the markets’ error.
The Dodd-Frank changes make the plan less awful, mainly by creating an equity stake. Essentially, this makes it possible for the plan to do the right thing through the back door: use toxic-waste purchases to acquire equity, and hence inject capital after all. Also, the oversight means that Treasury can be prevented from making the plan a pure gift to financial evildoers. But it’s still not a good plan.
On the other hand, there’s no prospect of enacting an actually good plan any time soon. Bush is still sitting in the White House; and anyway, selling voters on large-scale stock purchases would be tough, especially given the cynical attacks sure to come from the right. And the financial crisis is all too real.
So is it better to have no plan than a deeply flawed plan? If it was the original Paulson plan, no plan is better. Dodd-Frank-Paulson may just cross the line — let’s see what details we have if and when agreement is reached.
If the plan looks not-awful enough, I’ll be pro. But I won’t be cheering — I’ll be holding my nose.
Today, in response to several questions, Krugman posted the following:
I’m being asked two big questions about this thing: (1) Was it really necessary? (2) Shouldn’t Dems have tossed the whole Paulson approach out the window and done something completely different?
On (1), the answer is yes. It’s true that some parts of the real economy are doing OK even in the face of financial disruption; big companies can still sell bonds (and have lots of cash on hand), qualifying home buyers can still get Fannie-Freddie mortgages, and so on. But commercial paper, which is important to a lot of businesses, is in trouble, and I’m hearing anecdotes about reduced credit lines causing smaller businesses to pull back. Plus there’s a serious chance of a run on the hedge funds, which could make things a lot worse. With the economy already looking like it’s headed into a serious recession by any definition, the risks of doing nothing look too high.
It’s true that we might be able to stagger through with more case-by-case rescues — I think of this as the "two, three, many AIGs" strategy; in fact, we might not be at this point if Paulson hadn’t decided to make an example of Lehman. But right now it’s not even clear who to rescue, and the credit markets are freezing up as you read this (1-month t-bill at 0.04 %, TED spread at 3.5)
On (2), the call is tougher. But putting myself in Barney Frank or Nancy Pelosi’s shoes, I’d look at it this way: the Democrats could start over, with a bailout plan that is, say, centered on purchases of preferred stock and takeovers of failing firms — basically, a plan clearly focused on recapitalizing the financial sector, with nationalization where necessary. That’s what the plan should have looked like.
Maybe such a plan would have passed Congress; and maybe, just maybe Bush would have signed on; Paulson is certainly desperate for a deal.
But such a plan would have had next to no Republican votes — and the Republicans would have demagogued against it full tilt. And the Democratic leadership cannot, cannot, be seen to have sole ownership of this stuff.
So that, I think, is why it had to be done this way. I don’t like it, and I don’t like the plan, but I see the constraints under which Dodd, Frank, Pelosi, and Reid were operating.
Brad Delong had argued for a Swedish-style nationalization (something Krugman also says would have been better), yet he ultimately falls into the "hold your nose and vote yes" caucus.
Hold Your Nose and Vote for Paulson-Dodd-Frank
The Swedish model is better, but doing nothing is like a poke in the eye from a Lawn Dart(TM).
He also agrees with Larry Summers that the plan will ultimately cost far less than $700 billion and should not hobble an Obama administration's priorities.
How Much Will This Cost? How Does This Constrain the Policy of an Obama-Biden Administration?
Larry Summers's answers are "not much" and "not at all." I agree:
Lawrence Summers - Taxpayers can still benefit from a bail-out: The American experience with financial support programmes is somewhat encouraging. The Chrysler bail-out, President Bill Clinton’s emergency loans to Mexico, and the Depression-era support programmes for housing and financial sectors all ultimately made profits for taxpayers. While the savings and loan bail-out through the Resolution Trust Corporation was costly, this reflected enormous losses in excess of the capacity of federal deposit insurance programmes. The head of the FDIC has offered assurances that nothing similar will be necessary this time. It is impossible to predict the ultimate cost to the Treasury of the bail-out programme and of the other guarantee commitments that financial authorities have – this will depend primarily on the economy as well as the quality of execution and oversight. But it is very unlikely to approach $700bn and will be spread over a number of years....
[T]he usual concern about government budget deficits is that the need for government bonds to be held by investors will crowd out other, more productive, investments.... To the extent that the government purchases assets such as mortgage-backed securities with increased issuance of government debt, there is no such effect.
Third, since Keynes we have recognised that it is appropriate to allow government deficits to rise as the economy turns down if there is also a commitment to reduce deficits in good times.... [T]he US made a serious error in allowing deficits to rise over the last eight years. But it would be compounding this error to override what economists call "automatic stabilisers" by seeking to reduce deficits in the near term. Indeed, in the current circumstances the case for fiscal stimulus – policy actions that increase short-term deficits – is stronger than at any time in my professional lifetime. Unemployment is now almost certain to increase... to the highest levels observed in a generation. Monetary policy has very little scope.... [E]xperience around the world with economic downturns caused by financial distress suggests that while they are of uncertain depth, they are almost always of long duration.... The more people who are unemployed the more desirable it is that government takes steps to put them back to work by investing in infrastructure, energy or simply through tax cuts that allow families to avoid cutting back on their spending....
We still must address issues of entitlements and fiscal sustainability.... [T]he worst possible actions... would be steps that have relatively modest budget impacts in the short run but that cut taxes or increase spending by growing amounts over time.... The best measures would be those that represent short-run investments that will pay back to the government over time or those that are packaged with longer-term actions to improve the budget. Examples would include investments in healthcare restructuring or steps to enable states and localities to accelerate, or at least not slow down, their investments...
What's my point? Economics is an art, not a science. Ask three economists a question and you'll get three different answers.
I honestly don't know whether we should enact the bailout -- both Roubini and Baker make good points, but I don't think this will end up costing anywhere near $700 billion. Although I do worry that, even if this shouldn't hobble an Obama administration, opponents of spending may well (as Baker points out) argue against spending anyway.
Ultimately, however, my main argument is against the knives and pitchforks. Several good progressives DO think a bailout is necessary and that this is better than doing nothing. Others disagree, but its foolish to cherry-pick, declare that only those who embrace your views qualify, and then rail against those who support the bill as backstabbers and enablers. There are plenty of people acting in good faith -- they may be wrong, but the idea that everyone voting for this is selling out to corporate donors is knee-jerk reductionism.
Again, I'm an agnostic on the bill. But I'm willing to wait and see how this pans out.