Arnold Kling  

Morning Commentary

The Ignorance Behind the Pauls... Are Credit Markets Locked Up?...

I will update this post as new items merit attention. First, my latest essay opens,

I am concerned that the bailout might be the cause of the problem that it purports to solve.

I am re-using Karl Kraus' famous quip about psychoanalysis. Read the whole thing, and you can decide whether what I am offering is analysis or just psycho.

Steven Pearlstein writes,

What responsible, honorable people do is apologize for their mistakes, promise that it won't happen again and vow that they'll make it up to us once the crisis has passed. But in the past year, we've not heard any of that from the titans of Wall Street.

Pearlstein never raises the issue of an apology from anyone in Congress. They might be considered automatically exempt from standards for responsible, honorable people.

Tom Brokaw offers exactly the right tone on the bailout.

Glenn Hubbard, Hal Scott, and Luigi Zingales write,

The Treasury plan does create a large and willing buyer, an element missing in the markets until now. But at what price? If Treasury pays close to par, (as Fed Chairman Ben Bernanke seemed to suggest at the Senate hearing yesterday), it is paying far too much. If it pays current prices, no one will sell due to the impact on their capital. If it pulls a price out of a hat, it will be acting arbitrarily. The proposal needs to articulate the price-setting process.

Whether this is a fatal flaw or just a minor detail is what I talked about here.

The authors do not offer a clear alternative. I do, in the essay linked to at the beginning of this post. Yes, it's another plug for my idea of capital forbearance.

Ed Glaeser says house prices are mean reverting. He also writes,

If a housing market has increased by 100 percent over the last five years, then mean reversion implies expected price declines that can easily wipe out that 20 percent cushion.

Yes, but if every lender requires a 20 percent down payment, you are less likely to get such a rapid run-up of prices. Thanks to reader John Alcorn for the pointer.

Tyler Cowen looks at the Dodd plan.

It is easy to say that the Paulson plan is worse. (Oddly I think the Paulson plan makes most sense in Paul Krugman's multiple equilibria model for asset values.) But you shouldn't think that the Dodd plan is very good. Most of the Dodd plan boosterism I've seen doesn't look very closely at how it actually going to work. There's lots of talk about justice and the taxpayers getting upside and then a reference to the RFC from the New Deal.

Many links from Mark Thoma, including Martin Wolf, who speaks of Paulson's plan in the past tense.

Kaimpono D. Wegner suggests that instead of giving the money to banks, the bailout should go to homeowners. He points out that if the ultimate goal is to help households, this is a less indirect route than giving the money to banks.

But I have the most indirect route of all. Instead of having households give the money to government, and the government gives the money back to households, why doesn't every household write a check to itself for $5000? That would inject about $700 billion into the economy. Am I brilliant or what?

Comments and Sharing

COMMENTS (12 to date)
Sammler writes:

The government is even more brilliant than you are, alas, since a subsidy to homeowners amounts to a transfer from income earners to property owners -- from Labour to Capital! Who says this country is moving to the left?

floccina writes:

From an older link where land use regulation/slow growth policies are discussed - couldn't this be the way that they contributed to the bubble:

People look at payments to decide what house they can afford, so low interest rates, in areas with slow growth policies drive prices of existing homes up leading people to speculate in housing borrowing to where the payment is bigger than they would otherwise. If people are free to build existing home prices might not rise with lowering interest rates and thus payments but could instead be replaced with bigger better homes making speculation in housing not look so great.

mbc writes:

If we give the money to either the Wall Street firms in trouble or the homeowners in trouble, we are giving it to the very people who made the bad decisions.

Why not give it to people who did not make bad decisions? It will still stimulate and support the economy. So let's destribute to homeowners who are not behind in their mortgages and to investment firms that were not involved in the subprime market.

(If your broker's advice causes you to lose money, do you continue to give him more of your money to invest?)

E. Barandiaran writes:

Greg Mankiw links to Allan Meltzer who yesterday said:

"And if they're going to do something, then what they ought to do is make loans, which the financial institutions have to repay with interest. And if you think -- that's an idea which the Chileans have used in a bigger crisis than this for them in 1982, and it worked for them.
People paid back the loans. They weren't allowed to pay dividends until they repaid the loans. They weren't allowed to take bonuses until they repaid the loans. I think that's the way -- if we're going to do this, then that's the way we should do it."

Actually, Chile's Central Bank purchased assets from banks (this is what Allan calls loans to financial institutions/people). The key issue is the terms and conditions of the purchase of assets as Allan mentions in the second paragraph.

aaron writes:

I see the bailout as dumping money on bubble.

If there is a bailout, it should be in the form of lower interest rates or the write-off of a portion of priciple to decrease default risk.

aaron writes:

Or, we tax people who default at 50% for the rest of their lives until the debt is paid off.

silvermine writes:

Giving money to the homeowners does not avoid the moral peril. It screws me for a *third* time.

First, I have no house because I'm responsible and couldn't not afford one. Second, take my money away for ridiculous taxes. Three, give that money to someone with a house. That does not get me a house. It props up the ridiculous prices of houses, keeps people from selling houses they never should have bought, and I'm renting for the next 30 years, because the house market STAYS in a bubble, and all my money is taken in taxes.

Thanks! That would be grand.

shayne writes:

In the same vein as Tom Brokaw ...

(altogether now)

I pledge allegiance to the flag,
of Goldman Sachs (now) Commercial Bank,
and to the republic which it owns,
one bank, immune from law,
with indebtedness and taxes for all.

Lord writes:

Using strict qualification, lower downs means they cannot afford as much so does not lead to rising prices. Without qualification, even higher downs does not mean they can only afford less so can still lead to rising prices. Without qualification is just another means of printing money. Higher downs slow down rising prices, but once they take off would make the result more vicious.

Paul in NJ writes:
Steven Pearlstein writes, What responsible, honorable people do is apologize for their mistakes, promise that it won't happen again and vow that they'll make it up to us once the crisis has passed. But in the past year, we've not heard any of that from the titans of Wall Street.

Um, isn't this the same fellow who, speaking of Wall Street on CNBC last weekend,

"They fooled themselves. They didn't fool us, they fooled themselves, and they were fooling us in process."

So, um, which is it?

John Maxwell writes:

I thought that the bailout plan was an auction. The government would offer a billion dollars at a time to the bidder offering to take the biggest haircut. People with the most toxic waste would be willing to take the biggest haircut. If banks couldn't afford to take a haircut, then they wouldn't make an offer. Doesn't this solve the pricing problem? Healthy banks would be able to sell their toxic waste at a reasonable price. Unhealthy banks would go bankrupt.

Arnold Kling writes:

You don't know what the haircut is if you don't know what the securities are worth, I tell you I'm selling securities for 10 cents on the dollar and you say that's great, you'll buy some. But maybe they are really worth 5 cents on the dollar, and you would have been better off going with somebody's honest offer to sell for 20 cents on the dollar.

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