Mankiw, Rogoff, and Merton

The financial sector is important up to a point of aggregation where risk is more or less spread across all sectors of the economy. That is, the average saver can efficiently invest across the yield curve with surplus funds.

Once we get close to that point, any more financial sector costs a extra high transaction costs for each additional increment of risk reduction. Ken is right, we have moved beyond an efficient financial sector.

Hi Arnold,

FYI, I quoted you for a contribution to the Boulder Daily Camera (Colorado, circulation ~ 30k print), and it was published in today's edition:

A bailout allows government to do even more harm. As former Freddie Mac senior economist Arnold Kling explains at EconLog, the "bailout is going to lead to the same two-way influence peddling. ... An orgy of lobbying is bound to ensue. ... it creates a tight interlocking between Big Finance and Big Government [and the] the consequent destruction of liberty and economic dynamism."

I don't agree with this column, but here is Bruce Bartlett supporting the bailout. Here's an excerpt.

There are, of course, policies in place today that didn't exist in 1929 that make another Great Depression unlikely. (The most important is federal deposit insurance for the vast bulk of deposits.) But there is still a great danger that, if the financial sector becomes overloaded with assets falling in value, it could lead to a long period of economic stagnation, such as that suffered by Japan in the 1990s.

One reason for this is that Federal Reserve policy becomes impotent when the financial system simply can't distribute changes in the money supply throughout the economy.

We're seeing evidence of this already, as interest rates on Treasury securities fall to very low levels. When this happens, we have what economists call a "liquidity trap" - and it means that the Fed is incapable of stopping a deflation once it gets started.

Bottom line: We're closer to the precipice than Congress or most of the public understands. Our entire economic system really is at stake - and those treating the bailout plan as just another government spending program are seriously wrong.

Would suggest that people mark to market on the way up, but are slow to do so on the way down.

Maybe it was different in DC, but in CA the optimism at the height of the bubble was palpable. Now that things are down, all you ever see/hear is, "Things suck over in X neighborhood, but my neighborhood is just fine."

People will be shocked.

The financial sector is an export sector for the United States. How will this affect the trade deficit?

top executives and regulators do not understand the technical characteristics of today's financial instruments.

In journalism, putting this anywhere other than at the beginning of the article - but especially at the end - is called "burying the lede."

I thought that Warren and Merton did a great job of defining and characterizing the issues. Rogoff has the correct tone -- and I'd elect him to lead the debate.

Mankiw stumps me. I've been reading him for a couple of years, but I'd never seen him before. He never says much that's original, provocative, or profound. Now I see that none of these faults are redeemed by his personality or presence.

Rogoff points out that the financial sector accounts for 4% of GDP and 30% of US corporate profits. Wouldn't this usually mean that the financial sector should be expanding?

Did anyone notice the bootlegger and baptist moment in the question period, when the guy from a bank who was also a regulator (!) testified in support of Warren's claim that more regulation is essential?