Arnold Kling  

Cochrane and Rogoff on the PBS News Hour

Henry Waxman's Hearings... The International Angle...
I'll try liveblogging.  Here is a transcript.  For what Rogoff was thinking the other day, see this op-ed.  (We exchanged emails briefly on Saturday.  He mentioned he was writing something, and it sounds like he's shifted a bit between then and tonight on PBS)  Thanks to reader John Alcorn for the PBS tip and to Mark Thoma for the pointer to the op-ed.

(Update:  More Cochrane here)

Cochrane:  latest legislation "a pinata full of ridiculousness"

Rogoff:  better than the one Friday, "I wouldn't have written it, but we've gotta do it."  If Congress says "drop dead," there will be chaos.  Likes the increase in deposit insurance limits.

I've moved the rest below the fold.

Rogoff is saying that we have a widespread run in financial markets, and we have to do something to stop it.  Cochrane is saying that this won't work.

I think Cochrane is right in terms of logic.  But if market were being logical, we wouldn't be seeing institutions refusing to lend to one another and everybody going into Treasuries. The case for the plan is that it will restore confidence by magic, as Cochrane puts it. 

Rogoff says that no matter what there are a lot of insolvent banks.  It's interesting that no policymaker has come right out and said that.  If he's right, then the taxpayers will end up owning a lot of bad assets regardless.  But is he right? 

If a lot of banks are in trouble because they loaded up on mortgage securities, then it is important to understand why.  Capital regulations punish a bank that does mortgage lending the old-fashioned way.  That is, if a bank gives you a mortgage loan and keeps the loan, waiting for you to make your payments, that is considered risky.  On the other hand, if the bank buys some agency-rated security backed by mortgages that were originated by completely different lenders using totally unknown underwriting methodology, that is considered safer for capital purposes.

This is what I mean when I say that the secondary mortgage market is a cesspool of rent-seeking and regulatory arbitrage.  It is what I mean when I say that the problem of suits not understanding geeks is an issue.  A rational, apolitical regulator who understood mortgage credit risk pricing would never have set up capital requirements that induced banks to prefer exotic mortgage securities to old-fashioned mortgage lending.  If Rogoff is right, and lots of banks are insolvent because of their mortgage security portfolios, then we're all victims of a swindle perpetrated by Wall Street on bank regulators.

I hope that he is wrong.  I hope that the banks are actually sound, and that the financial crisis is just a panic taking place at the institutional level, being fed largely part by fear-mongering and incompetence of public officials.  Anyway, lots to chew on....  

Cochrane:  lots of things we can do instead.  how is the bill going to restore confidence?  the bill is supposed to be "magic."

Prof. Rehman (from George Washington University):  middle america will be hit if this bill does not pass; need restore confidence, bail these companies out "rightly or wrongly."

Rogoff "It is not going to work."  Eventually we will have to inject capital into the banks.  We have to close a lot of the banks.  This is not the last word.  It will eventually cost a lot more.  We've go to close the insolvent banks.  We cannot just rain money on everyone.  We've go to show we're moving.  We can't debate what might be a better plan.

Cochrane:  the plan is try to raise the value of all mortgages in the country.  At the same time, the Senate said we're not going to make people pay back mortgages.

Rehman:  it has to get done.  The Treasury Secretary has confidence in the experts around him.

Rogoff:  a lot banks have to get closed.  There just isn't a pretty way to do it.  "an epic crisis" we've done a good job of getting a lot banks closed.  We've been tough, not like Japan.  But we need to step in and stop the run.  Somebody has to put a stop.

Cochrane--this plan will end up doing nothing, costing a lot of money, and down the road we'll just end up doing the things Ken's talking about.

Rehman.  hard part is sussing out the assets--banks could slip some really bad stuff onto the taxpayers

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The author at Knowledge Problem in a related article titled Revised bailout plan: OK, now I'm not just skeptical, I'm angry and disgusted writes:
    Lynne Kiesling Before I read the Senate version of the revised bailout plan, I generally agreed with Tyler Cowen: "The modified Paulson plan was better than nothing -- especially after the market had been scared -- but far from my... [Tracked on October 2, 2008 9:11 PM]
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non-economist writes:

Why not let the banks fail and eat our crap sandwich one bite at a time? Either way, taxpayers foot the bill. Cries that we have to do something big, right now, or the end will come remind me too much of timeshare/vacuum-cleaner salesman tactics.

parviziyi writes:

I want to see data about the ordinary banks' exposure to the mortgage securities problem. The government's proponents of the bailout have an obligation, in my view, to come up with this data. The fact that such data hasn't been presented is a key reason why many are saying the bailout has not been justified. I realize the securities are multi-tiered (etc.) and that the data may not be susceptible to easy presentation.

If anybody knows the whereabouts of approximations of such data, I'd be grateful for a link to it.

Bill Woolsey writes:

The Federal Reserve publishes data on categories of bank assets. Total mortgages and securities are vast compared to consumer loans (like credit cards) and commercial loans.

Ray Lopez writes:

Professor has made a similar point to the below. But I reproduce my article since I developed these ideas de novo. I am not an economist. -Ray

I have a theory about the bailout crisis: it's routine--a routine credit contraction caused by overexpansion. I would welcome a comment from the readers of this blog.

Here's how to prove this yourself: Google "The Curve in the Road by John Mauldin". Look at the two graphs for LIBOR over the last year and for commercial paper outstanding since 1990. Two things stand out: LIBOR also spiked in Dec 07 and from Mar-May 08--to 2% from 0.5%. This past 30 days it spiked from 1% to 3.5%. To me, it doesn't seem unprecedented. I've heard that in the early 1970s a similar spike occurred (can anybody confirm this?). Second, and most damaging: the reduction in commercial paper is not historically abnormal now. From 2000 to 2003, commercial paper dropped 19% (look at the graph: 1600 to 1300). From 2006 to 2008 (today's crisis) commercial paper outstanding dropped 25% (2200 to 1650). Severe yes, but, again, not totally unprecedented.

Can we therefore say that this credit crisis is a 'routine' (albeit severe) response to the credit expansion we've had over the last five years or so? If so, then why did Bernanke and Paulson panic? Could it be that as middle-aged men who have never witnessed a severe credit contraction (such as happened in the early 1970s and early 1980s), they overreacted? Of course, more cynical and sinister theories are possible, but this is the benign theory: they were simply over their heads in responding to a relatively normal credit contraction. And we taxpayers have to pay, as well as setting an extremely damaging precedent for the USA.

One final note: you can argue that "but for" the government intervention, the contraction in commercial paper would have been much more severe, which therefore justifies the intervention. But this is complete speculation. In fact, you can argue that $700 B is not enough to prevent further contraction, and therefore this argument is circular.

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