Morning Commentary

What both you and Tyler seem to miss is that it is insolvency of the mortgagor that is a key problem here. It was not the failure of the markets, but backdoor Keynsianism that led to the this roller coaster to serfdom. The market did not guarantee and facilitate the securitization of the mortgages. The market did not bail out LTCM, S&L's, Chrysler, Continental, etc.. The federal government did. The legal requirement lending were a lot closer to Hobbes than to Smith.

The fix, rather than bailout of the banks, is a partnership between the treasury and the homeowners.

1. Each homeowner behind in payments may submit a tax credit for up to twelve month of back payments. This can only be for back payments.
2. The feds owns whatever percentage of the house they just paid for (So if you have 20,000 in equity and the feds pay for 20,000, they own 50% of the equity at sale) I think a standard tax lien handles the transaction.
3. Any homeowner accepting these payment must pull their house off the market for 3-6 months depending on the number of payments received.
4. The payments are distributed as a tax credit—but directly to the bank/mortgage owner. This targets the money toward toxic assets instead of the best lobbyists.

Then
Let FDIC close the banks that are still insolvent and mover the accounts to other solvent banks.

Moral hazard does raise its specter here, but I think no worse than the trillion dollar bank bailout.

Furthermore comment on banking and bubbles is rather an old topic. See--
http://www.jstor.org/stable/60205873
for a fun read.

[N.B. Neil Pelkey's jstor.org link leads to an 1828 republication of a David Hume (1711-1776) tract: "An address to the proprietors of bank stock, the London and country bankers and the public in general, on the affairs of the Bank of England". I wouldn't have described the original or the republication as "a fun read."--Econlib Ed.]

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"The bank is not allowed to make any new risky loans, but otherwise it can continue to operate. The bank can borrow from the government to cover short-term liquidity needs, but not to expand operations, pay dividends, or compensate executives in cash (it can award them stock or stock options)."

I agree with your plan to take a hard line approach on this crisis, but if you enact the above on shaky banks, they will quickly turn from shaky to downright insolvent. Banks need to expand operations and make new loans in order to earn their way back to insolvency. If you don't allow well-compensated executives (hopefully they bring in someone new), to make new (who defines what is risky? gov technocrats?) loans, and expand operations, they will never earn their way back to solvency. So your plan for shaky banks would lead to the tourniquet procedure for the vast majority of banks entering the plan, wouldn't it?

Correction: 'earn their way back to SOLVENCY' not insolvency

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Paul Volcker was reacting perfectly normal, but he has forgotten "why the worst get on top" (Hayek), so, the "Nuremberg defense" from geeks sounds plausible to me (that does not free of responsibility those specific quants).

David Colander continues to be one of my heroes.

This is just awesome:

"In our view, economists, as with all scientists, have an ethical responsibility to communicate the limitations of their models and the potential misuses of their research. Currently, there is no ethical code for professional economic scientists. There should be one."

If you've seen CNBC's "House of Card" you know that Alan Greenspan essentially took the Nuremburg defense himself -- "the Congress wouldn't have let me shut off the money explosion filling the housing bubble."

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Some comments against regulation (without extremes) seem the discourse of the radical conservationists: every increase in emissions will lead us to a cataclysm.

Nevertheless, Hayek has written on the extreme situation post WWI and the socialist preconditions of Germany as the background to the Nazism.

??

The Colander et al paper comes out of a conference held in Dahlem in Germany in December. I was originally scheduled to be in that session there, but was too busy to attend. If I had, there would have been nine coauthors and some relatively minor changes, not worth discussing. I am largely in agreement with it.

In reply to Arnold on his "lost history paper," which I think is quite fine, I would make two points. One is that I do not see it as dealing directly with Colander et al. While there is an advocacy of some alternative econometric approaches, I do not see those as addressed by your paper. Furthermore, the main argument had to do with using agent-based modeling. Do you disagree with that.

Also in connection with your paper, I do not think that the Lucas critique is necessarily tied to assuming rational expectations. Of course, Lucas made that link, but the argument that people might change their behavior based on a change in their expectations in response to changes in government policies was one made by Keynes in criticizing the macroeconometric modeling by Tinbergen, as well as somewhat more formally in 1950 by Jacob Marshak. However, they avoided the fantasyland assumption that somehow people would be adjusting their assumptions according to rational expectations.