The Great Bailout Brouhaha

Free market economists weigh in on Paulson's plan

As Congress and President Bush set to "hammering out the details" of a proposed $700 billion bailout for investment banks, reason asked free-market-friendly economists three pressing questions: How bad is the current market situation?; how bad are the current proposed bailout plans?; and what's the one thing we should be doing that we're not?

Their answers are below. Reactions should be sent to [e-mail]. 

Bryan Caplan

1. How bad is the current market situation?
To be honest, I'm not too sure. While we're blaming banks and investors for their "herd behavior," we should remember that politicians and the media often run with the herd, too. When the dust settles, I suspect we'll realize that conditions weren't as bad as people assumed—or at least they weren't until we tried to fix them.

2. How bad are the current proposed bailout plans?
Again, to be honest, I'm not too sure. The plans are creating a bad precedent—perhaps the worst precedent since the New Deal. But it's worth remembering that a "$700 billion bailout" doesn't literally mean that the government gives $700 billion to investors. Instead, it means that the government can buy $700 billion worth of assets; the transfer to investors is only the difference between $700 billion and the fair market value of the assets.

I should add, though, that I don't think the people spearheading the bailout have a clear idea about what they're doing either. They remind me of the old saying: "Something must be done. This is something. Therefore this must be done." I'm a former student of Chairman Ben Bernanke and his behavior during this mess has been a big disappointment.

3. What's the one thing we should be doing that we're not?
Waiting a couple of years. Unemployment is only 6.1 percent; by standard measures, we're still not in a recession. Even if you have no libertarian sympathies, shouldn't you at least give familiar, low-impact responses (especially standard monetary policy) before you throw caution to the wind?

Bryan Caplan is an associate professor of economics at George Mason University and the author of The Myth of the Rational Voter.

(Responses continue below video box)

Click above to watch economist Arnold Kling, founder of Homefair.com, Econlog blogger, and former Freddie Mac employee, talk about the bailout plan.

Robert E. Wright

1. How bad is the current market situation?
The current situation is potentially dire. The comparison with 1932-33 is sobering: An unpopular Republican president is in office, the financial system is a mess, and an important election looms, yet many fear what the articulate Democratic candidate might do if elected. We won't have to wait until March to find out this time around. But given how fast the world moves these days, late January will seem an eternity away. The payments system broke down last time (March 1933), necessitating a bank "holiday," a moving speech ("the only thing we have to fear is fear itself"), and creation of the FDIC (Federal Deposit Insurance Corporation). Breakdown of the payments system today would stagger the economy. During the Depression we didn't have to worry about hackers and terrorists but they must be salivating now. They will probably wait until after the election, but they will almost certainly try to kick us while we are down, just like they did during the last two recessions (1990 invasion of Kuwait and 9/11).

2. How bad are the current proposed bailout plans?
The current bailout plans are so bad it's impossible to tell just how bad they are with any precision. The devil, as they say, is hiding in details that are either undisclosed or will be concocted on the fly. For example, it is clear that some sort of tax will have to be placed on financial institutions that grow TBTF (too big to fail). If the tax is too high, financial services firms will stay small and the United States may lose, or be unable to regain, its competitive advantage in some important financial areas. If the tax is too low, financial services firms will merge and conglomerate at a rapid pace just to avoid "Lehmanasia" (euthanasia if they are not big enough to represent a systemic risk) during the next crisis. If the tax is just right, only those companies that need to be huge to compete internationally should be willing to pay it. The probability that regulators will get this and similar issues right appears small indeed given their track record.

3. What's the one thing we should be doing that we're not?
There are many things that policymakers are not doing that they should be. One is thinking long and hard about how to improve regulation. Clearly, both regulators and financiers need to know more about economics and financial history: Paying mortgage originators their full commission upfront was an affront to both theory (incentives matter big time) and history (the failure of six previous mortgage securitization schemes in the U.S. between the Civil War and World War II for the same reason). Equally clearly, compensation structures within financial services firms need to put much more weight on long-term or deferred compensation. Yearly bonuses may be appropriate for some (e.g. traders) but are clearly not appropriate for others (e.g. executives). Only then will managers eschew short term profits for long term gains, as they used to do when they were partners in private concerns.

Robert E. Wright is clinical associate professor of economics at New York University's Stern School of Business and the author of One Nation Under Debt.

Jeffrey A. Miron

1. How bad is the current market situation?
The current situation is serious, but not so much because the economic conditions are especially bad. The situation is serious because policymakers seem poised to undertake an enormous intervention that will have huge adverse effects and may well exacerbate the very kind of problem the intervention is meant to fix.

2. How bad are the current proposed bailout plans?
See #1. The bailout is a terrible idea. It transfers a huge amount of wealth to people who do not deserve it. It will generate enormous incentives for creative bookkeeping as the investment houses and banks try to rid themselves of any assets they do not want. The bailout fails to eliminate the crucial policies that contributed to and caused the current situation, such as the Community Reinvestment Act, the creation of Fannie Mae and Freddie Mac, and so on. Last but hardly least, the bailout sets a terrible precedent: If you take huge risks and become too big to fail, the government will bail you out.

3. What's the one thing we should be doing that we're not?
The only things we should be doing are eliminating the underlying policy causes of the current situation; see #2.

Jeffrey A. Miron is senior lecturer and director of undergraduate studies in the Department of Economics at Harvard University.

Chris Dillow

1. How bad is the current market situation?
No one knows! Our problem is one of Knightian uncertainty; we just don't know (and banks themselves don't know) what those illiquid mortgage derivatives are worth. If I were looking for comfort, I'd point out that the non-financial, non-housing economy has held up OK during the first 13 months of the crisis, so perhaps the linkages between the financial and "real" economy aren't as strong as feared. And there's some evidence that housing transactions are, at least, falling less quickly.

My problem is that, even before Lehman Brothers collapsed, the U.S. was likely to have a mild recession over the winter. The danger is that this'll increase risk aversion.

2. How bad are the current proposed bailout plans?
They're sub-optimal rather than terrible. It would be better if banks could be recapitalized either through debt-equity swaps as Luigi Zingales has suggested, or through a government order to stop paying dividends and hold rights issues, or through partial nationalization. I'm not so worried that the plan will cost taxpayers heavily—it might not—as by the social injustice of it. The welfare state seems more generous for bankers than for the poor.

3. What's the one thing we should be doing that we're not?
Apart from keeping our heads? Remember the distinction between capitalism and free markets. This crisis raises many questions about the merits of capitalism—and in particular the massive gap between ownership and control that afflicts quoted companies—but does not undermine the case for free markets.

Chris Dillow is economics writer at the Investors Chronicle. He blogs at Stumbling and Mumbling.

Frederic Sautet

1. How bad is the current market situation?
Very bad. It could be one of the worst business cycles since World War II or more. There is a mountain of malinvestments. This is coupled with over-leveraged investment banks and other financial institutions that have been using new financial instruments carelessly for a decade because of the perverse incentives in the system.

2. How bad are the current proposed bailout plans?
This is socialization of the banking industry, plain and simple.

3. What's the one thing we should be doing that we're not?

Getting out of the mess is not going to be easy. Once the perverse incentives are in the system, it's hard to go back. Bailing out is very bad and in the long run is worse than bankruptcy. It is not a coincidence that Paulson is the former CEO of Goldman Sachs and is now bailing out his friends. The problem is that bankers should be punished for their careless, stupid investments (JP Morgan, for instance, has $8.1 trillion in credit derivatives on its books), but since it was largely driven by the government's loose monetary policy and regulation, bankers are not the only ones responsible. Clearly letting the banks fail in the short run would have bad consequences for many households in the U.S. (and elsewhere). The problem is that the government does not have the incentives to intervene just for a short time. Once the banks are nationalized, it may take a while before the government leaves the place. Ultimately, this situation calls for radical policy solutions: The return to the gold standard and the abolition of central banks. reason should run a special issue on this theme.

Fredric Sautet is a senior research fellow at the Mercatus Center at George Mason University.

Mark Thornton

1. How bad is the current market situation?
I believe that the current state of the economy is worse than at any time during my life. Debt and future obligations of the federal government are daunting and the personal finance of the average American is extremely weak. The capital and financial imbalances in the economy are extreme. Ultimately this is due to the fiat dollar, fractional reserve banking, and the central bank (i.e., the Federal Reserve).

2. How bad are the current proposed bailout plans?
The actions taken over the last year and the pending bailout of Wall Street have not and will not help. They have made and will make the economic situation much worse. This is the exact same approach that took us into the Great Depression. There is no reason to expect the correct solution from the same people who created the crisis in the first place and who until very recently thought the economy was strong and that there was little or no chance of recession.

3. What's the one thing we should be doing that we're not?
The most important reform is to recognize the legal monetary status of gold and silver as intended in the Constitution so they can serve as an alternative money that is untaxed and unhindered by government interference. This would send a strong message throughout the world economy and begin to establish political pressure against monetary inflation and fiscal irresponsibility by government.

Dr. Mark Thornton is a senior fellow at the Ludwig von Mises Institute in Auburn, Alabama, and  the book review editor of the Quarterly Journal of Austrian Economics. His books include The Economics of Prohibition and Tariffs, Blockades, and Inflation: The Economics of the Civil War (with Robert B. Ekelund, Jr.). He is the editor of The Quotable Mises and The Bastiat Collection.

Yves Smith

1. How bad is the current market situation?
This credit crisis has already led to the biggest 12-month fall in household wealth in U.S. history, including during the Great Depression. It has not yet had a commensurate impact on economic growth because our foreign creditors provided what economist Brad Setser called "the quiet bailout," lending to us to the tune of roughly $1,000 per man, woman, and child. But it would be a mistake to expect this largesse to continue, at least at such favorable interest rates.

As Harvard University's Kenneth Rogoff and the University of Maryland's Carmen Reinhart found in their analysis of financial crises, every country that experienced a housing/bank crisis of the magnitude of the one we are in has suffered a marked fall in GDP. As they noted in their paper "Is the 2007 U.S. Sub-Prime Financial Crisis So Different? An International Historical Comparison":

At this juncture, the book is still open on the how the current dislocations in the United States will play out. The precedent found in the aftermath of other episodes suggests that the strains can be quite severe, depending especially on the initial degree of trauma to the financial system (and to some extent, the policy response). The average drop in (real per capita) output growth is over 2 percent, and it typically takes two years to return to trend. For the five most catastrophic cases (which include episodes in Finland, Japan, Norway, Spain and Sweden), the drop in annual output growth from peak to trough is over 5 percent, and growth remained well below pre-crisis trend even after three years.

Note that their study shows the U.S. to be on a trajectory considerably worse than the average of the five worst cases, suggesting our fall in growth will be at least as severe. And no public official in the U.S. is willing to tell the public that no matter how this crisis plays out, we will suffer a fall in our standard of living.

2. How bad are the current proposed bailout plans?
Frankly, they are dreadful. First, let's focus on the aspect that should get the proposal dinged (or renegotiated) regardless of any possible merit, namely, that it gives the Treasury imperial power with respect to a simply huge amount of funds. $700 billion is comparable to the hard cost of the Iraq war, bigger than the annual Pentagon budget. And mind you, $700 billion is not the maximum that the Treasury may spend, it's the ceiling on the outstandings at any one time. It's a balance sheet number, not an expenditure limit.

But here is the truly offensive section of an overreaching piece of legislation: "Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency."

This puts the Treasury's actions beyond the rule of law. This is a financial coup d'etat, with the only limitation the $700 billion balance sheet figure.

Second, the eagerness to pass this measure and Sen. Christopher Dodd's (D-Conn.) improved variant is based on the faulty premise that this package will actually salvage the financial system. It won't. Trying to prop up asset prices at above market levels is destined to fail, and worse, only digs us deeper in the debt hole in the process, making the ultimate resolution of our economic mess even more costly and painful. We are not alone in this view. Virtually no economist is in favor of the program (save Alan Blinder). The University of Chicago even published an open letter with a long list of signatories against it. And commentary on econoblogs has been as close to unanimity as one sees in these parts against it.

All it will do is provide a short-lived burst of confidence. Then, as market participants think through its operation and ramifications, the anxiety and stressed conditions will return. How long will the false euphoria last? Two weeks to six weeks, I'd hazard. And worse, the existence of this program will block any other course of action being taken. It is so large and resource-intensive an approach that it precludes other remedies.

3. What's the one thing we should be doing that we're not?
There are no plans, zero, zip, nada, for better regulation and oversight of banks. Given that the credibility of the U.S. financial system is in tatters, and we continue to depend on foreign capital to fund our government deficit, which will only grow as a result of interventions already underway and whatever new program is passed, we need to take a cold hard look at how to improve financial industry regulation, particularly regarding murky over-the-counter markets. 

Curiously, the U.S. seems to lack the appetite for reform despite the havoc that deregulation and lax oversight hath wrought. But whether we are keen for it or not, it behooves us to move quickly to try to clean up our industry, if nothing else, to try to restore faith in our markets and institutions overseas.

Yves Smith has written the blog Naked Capitalism since 2006. She has spent more than 25 years in the financial services industry and currently heads Aurora Advisors, a New York-based management consulting firm specializing in corporate finance advisory and financial services.

Robert Higgs

1. How bad is the current market situation?
How bad the current situation is depends on where you find yourself in the market system. So far, the troubles are highly localized in certain financial markets and, to a lesser degree, in the housing and related industries. Financial institutions that made foolish bets—all of them more or less contingent on perpetually rising real-estate prices—are in deep trouble, but the overall financial scene does not look bad. Lending continues at high levels; credit is not "frozen," as the media keep insisting. Outside the financial sector, conditions generally look OK for the moment.

2. How bad are the current proposed bailout plans?
The proposals already accepted or likely to be accepted add up, not to a house of horrors, but to a Five Star Hotel of Horrors. The bite taken out of the taxpayers—$700 billion to start with—is a huge injury with virtually nothing of value in return. The implications for future conduct are horrendous. To the old "too big to fail" rule, the government is adding "too well connected to fail." Moral hazard will be promoted tremendously, not to mention that the government is resorting to outright socialism by taking ownership positions in rescued firms, as well as pursuing the usual economic-fascist policies of subsidies and bailouts.

3. What's the one thing we should be doing that we're not?
Who's we, white man? The government would do almost all of us ordinary people a favor if it merely refrained from what it's been doing for the past few weeks, and simply let badly managed firms go bankrupt. Capitalism is supposed to be a profit-and-loss system. Too bad the so-called capitalists and their lackeys in the government don't believe in capitalism.

Robert Higgs is a senior fellow in political economy at the Independent Institute and editor of The Independent Review: A Journal of Political Economy. He blogs on the bailout and other topics at The Beacon.

Mike Munger

1. How bad is the current market situation?
We stand on a knife's edge. If confidence erodes further, people will run for the exits. And there aren't many exits. This is not a deflation, or a liquidity shortage. This is a problem of insufficient equity to cover liabilities. Our government is treating this like a bank run, when the problem is that banks are holding worthless assets.

A bank run can be stopped by an infusion of credit and cash. But in an equity crisis, throwing in cash is just pouring money down a rat hole. Worse, we are taking money from the taxpayers who earned it and giving it financial agents who squandered it.

2. How bad are the current proposed bailout plans?
Very bad. And I am confident they will soon be much worse on the way to getting passed. There are two main problems. The first is that we don't know what we are doing. The effects of the bailout are as likely to be catastrophic as beneficial.

The second is that current deficits are future taxes. We aren't saving any money; we are just pushing our problems into the future. If we aren't careful, we might precipitate a run on the dollar, with people dumping dollar-denominated assets in favor of Euros. That kind of run, given the amount of debt held in foreign hands, would make the current crisis look like a cake walk. 

3. What's the one thing we should be doing that we're not?
Let the price mechanism work. High gas prices, for example. We are trying to bring down gas prices. But high gas prices limit demand, elicit new supply, and make alternative energy more profitable. Same with low prices on mortgages and other financial instruments. Buying up worthless assets is like trying to drink the ocean to stop a flood. You can't do it. Let financial firms, like AIG, take the hit, and build fire lines to contain the contagion. Guarantee the assets of the folks AIG owes, and consign AIG to the flaming hell it so richly deserves.

Otherwise, we will have class war. If my mortgage is more than I can pay, why shouldn't the government bail me out? If AIG gets the grease, so should I.

Mike Munger is the chair of the Political Science Department and a professor of economics at Duke University. He is also North American editor of the journal Public Choice.

Alex Tabarrok

1. How bad is the current market situation?
Very short term credit markets are in bad shape although bank credit has so far managed to stay high albeit with declining growth rates.

2. How bad are the current proposed bailout plans?
The disaster is not so bad that more thought about what to do would not be beneficial.

3. What's the one thing we should be doing that we're not?
To avoid a credit crunch we should be encouraging savings. I propose a temporary but strong stimulus to savings which could be implemented by a) making the Roth IRA tax deductible for a year and eliminating the income limits and b) eliminating for a period of time any taxes on interest. Increased long-term savings will help to alleviate the credit crisis by providing funds and reducing the maturity mismatch which is creating liquidity problems. In addition, long term savings are good for economic growth.

Alex Tabarrok, Associate Professor of Economics at George Mason University writes regularly at MarginalRevolution.com. 

Comments

[TallDave]

1) Not that bad.

2) Not that bad.

3) We should be doing nothing instead of something.

[Franklin Harris]

3. What's the one thing we should be doing that we're not?

Whose we, white man?

Robert Higgs FTW.

[Kolohe]

Reactions should be sent to [e-mail].

I think I'll write them here thankyouverymuch. 🙂

I like caplans. I would say 'wait a couple of *months,*' vice years. First, the election will be over. Second, we will clearly see if we're getting in deept kimchi. And even if we are already in it, a few months is not too late to change course; a few years might be. And I'm hestitant to be too 'precautionary principle' with 'we're not in a recession and unemployment ain't all that bad'. While the values may be within spec, the vectors have been really bad for almost a year now.

Wright's is OK but:

During the Depression we didn't have to worry about hackers and terrorists but they must be salivating now. They will probably wait until after the election, but they will almost certainly try to kick us while we are down, just like they did during the last two recessions (1990 invasion of Kuwait and 9/11).

This is god awful. First, the frickin Nazis, Communists, Japanese, and plenty of others sure as hell took advantage of world wide economic weakness in the 30's; our 'enemies' today are not nearly the threat nor nearly as potent. And does he really think the timing of Kuwait or 9/11 had anything to do with the state of the US economy? That is nonsense on stilts.

The rest are fine, if somewhat predictable based on the writers' biases gleened from their bio sentences.

[Kwix]

From Mr. Dillow (horrible name BTW):

2. How bad are the current proposed bailout plans?
It would be better if banks could be recapitalized ... through partial nationalization.

3. What's the one thing we should be doing that we're not?
...
This crisis raises many questions about the merits of capitalism ... but does not undermine the case for free markets.

So, the way to preserve free-markets is via nationalization??? Thank god this dude is a blogger and not a professor of Econ.

[Orange Line Special]

It must physically hurt to be Reason right about now. The one time when people might pay attention to them, no one cares because they've blown what little credibility they might have had years ago by supporting other, incredibly stupid ideas.

[The Wine Commonsewer]

Orange, that makes absolutely no fargin sense at all.

If no one cares, and Treason has no credibility, how have they lost the audience they don't have?

[Episiarch]

LoneMonkey, stop projecting.

[DannyK]

Interesting. I get the strong feeling that what is being done won't help, and that what might help won't be done.

I think Mike Munger's point about a run on the dollar is underappreciated -- the rest of the world is watching the U.S. handle the crisis like the Keystone Kops, and I don't think they're amused.

The Germans are already criticizing us to our face, the Chinese are limiting further exposure to our banks -- the next step is for the lending nations to dump the dollar and dive for the Euro. Nobody is going to like that very much, except for the gold bugs who will feel vindicated.

[VM]

"Nobody is going to like that very much, except for the gold bugs who will feel vindicated."

psst - the goldbugs really don't understand much beyond their flabbering about gold, so no worries!

[VM]

(see: defending gold early 30s)
and sorry for double

[Bill Berger]

Credit is nowhere near frozen. Anyone with good credit history still has institutions lined up to loan them money.

Credit will probably get tighter which is what needs to happen anyway. People who do not deserve credit probably won't be able to get it. Good. This will be a boon to many local banks who struggle to be profitable when rates are so low.

The sky is not falling. Let the people who made bad decsions fail. Leave the rest of us alone.

[HyperIon]

two folks mentioned returning to the gold standard. i did not know this was even possible.

[jmd]

i made NO bad decisions. but my home value and retirement account are being wiped out cuz these assholes destroyed capitalism by figuring out how to pas on their risk to everyone else in the world (i.e. leveraging the hell out of worthless instruments). how can capitalism exist if the risk is divorced from the risk taker and instead dumped on those of us who did nothing? i'll be damned if i'm gonna watch my entire net worth disappear just to save a fucking theory.

[Andy Craig]

Mike Munger is also the Libertarian candidate for Governor of North Carolina, and manages very well to avoid both the insanity of the LP Radicals (due in large part, I imagine, to his mainstream academic prominence) and the arrogance and ineptitude of Barr and his camp. I think he'd be a great pick for the LP for Pres or VP in 2012.

[Jerry]

VW, the 1930ish gold standard is a bad example, because gold wasn't freely convertible then. Basically, you had the Americans inflating on their gold reserves. You had the British inflating on the dollar, and you had the rest of the world inflating on the pound sterling. I don't think a real gold standard under central banking has ever been tried.

[Michael Ejercito]

Whom exactly are we bailing out?

[Jeff]

1. What little evidence there is (see
http://www.federalreserve.gov/releases/cp/)

shows that nonfinancial firms with good credit quality are not paying much to borrow. Financial firms, especially low-rated ones, and those trying to borrow with asset-backed paper are paying higher rates. Given recent history, that's as you would expect.

Further, the tables at http://www.federalreserve.gov/releases/cp/outstandings.htm

show that, while there was a drop in nonfinancial commercial paper for the week ended September 17'th, it recovered a bit in the most recent week ending yesterday.

Most of the people who think the situation is desperate point to the elevated LIBOR, but there is less here than meets the eye. The Fed has been creating new lending facilities at a breakneck pace, and now has managed to lend out well over $400 billion in cash and Treasury securities. The discount window is wide open at 2.25 percent. Anyone actually paying LIBOR to borrow in the interbank market is nuts.

So why the panic? The financial sector has gotten too big and too leveraged over the past few years, and now it is getting smaller. The process isn't pleasant for people in that industry, but that's no reason for a bailout.

2. The bailout plans are worse than unnecessary; they are positively harmful. Not only does it reward the undeserving filthy rich jerks who created the mess, it encourages them to do more.

One way this will happen is via repatriation of foreign-held MBS. It has been widely reported that foreign central banks, particularly the Bank of China, hold large amounts of MBS. So do a number of foreign private banks. (Recall that most of AIG's CDS exposure was to European banks.) With the Treasury buying MBS from American institutions at above-market prices, the securities held by foreigners become more valuable to domestic banks than they are to foreigners. Domestic banks will buy securities from foreigners for resale to the Treasury, and we may well end up with just as much junk in domestic banks as we started with.

3. We should do nothing, except maybe come up with some accelerated bankruptcy procedures.

[Marc]

Jmd --

"i made NO bad decisions. but my home value and retirement account are being wiped out..."

You bought a home. That exposes you to risk to changes in its value. You bought stock or bonds. Guess what: those are risky, too. If you want to second-guess yourself with hindsight, then you should have rented, stuck your cash under a mattress or bought gold. I'm sorry, but don't pretend that you didn't take any risks, and therefore that you should be immune to drops in market value.

[Kolohe]

Just to be a little contrarian on Jeff's point #1, the 2nd graph on that page gives a layman with an engineering background like me some pause*.

When you have a parameter that is rountinely measured at 30 with occasional spikes to 100 or so, but then all of a sudden goes to 400, that can't be good for system dynamics. If I were responsible for a machine with those meter readings, I'd be hitting an emergency shutdown switch.

*OTOH, remember that both Hoover & Carter both had engineering backgrounds

[SIV]

i'll be damned if i'm gonna watch my entire net worth disappear just to save a fucking theory.

Past performance is no guaranty of future results.

[James Anderson Merritt]

Marc wrote, "If you want to second-guess yourself with hindsight, then you should have rented, stuck your cash under a mattress or bought gold."

I've been a renter for the past several decades, as at no time did I believe that housing in my area was worth what was being asked. To be fair, people have been declaring a bubble and its imminent popping for 30 years around here. I suppose I could have figured out a way to own a home and make money on the real estate in that time, but every time I was about ready to take the leap, some financial setback would throw me back in with the crowd of renters. Oh well.

The buying gold advice is good, but the advice to stash cash under a mattress (or keep it in a piggy bank or even a passbook account, for that matter) is a profoundly bad idea in a time of inflation. Holding cash is participating in the theft of your own purchasing power, which is engineered by those money-printing bastards in Washington. Owning tangible, durable assets that have a hope of appreciation in dollar value is your only way -- short of gambling, I mean -- to preserve your purchasing power, not to mention increase it. Keeping your money in a bank entails a risk that you might lose it all at once in a bank run and collapse. But keeping your money in cash or cash equivalents is not risky at all: you are GUARANTEED to lose nearly the entire purchasing power of your cash stash if you hold it long enough.

[Theresa K]

Jeff: Interesting idea, but why shouldn't we let China continue to hold onto that worthless paper?

I wonder how much of our national debt it would wipe out.

[P Brooks]

Whhen your only tool is a hammer, everything looks like a nail.

When you've been a banker all your life, you think the banks are the single most important sector of the economy.

[Mo]

This proves the point that if you get 10 economists in a room, you'll get 10 different opinions.

[von Laue]

The free market caused this. Therefore, the "economists" interviewed have no credibility. Fuck them and fuck you. Libertarians caused all this. This bullshit has finally hit Manhattan, and that means it is really serious. We had a great 20 years of easy money that didn't really help the economy, but made a fake fucking economy composed of selling houses to each other along with financial services to finance it all with crazy fucking leverage. But then a regulation wasn't passed, or something, meaning you lassiez-fairies fucked everything up. Also, no one cares what you think because you're fringe idiots. But don't forget that you fucked everything up with your stupid ideas that no one listens to. WAY TO GO FREE MARKETZ!!1!

Thank god the adults are in charge, and not stupid libertarians. In spite of your stupid DEMAND KURVE bullshit, there will be strong oversight of the economy from now on.

[rchellapilla]

I knew this bailout was a stinker when Bush warned us about dire consequences of not passing it. His administration has been so wrong for so long on the state of the economy, housing, inflation and the dollar why should we believe warnings now.
This bailout is the ultimate moral hazard nightmare and who knows the unintended consequences that will result.
The main cause of this "crisis" is falling home prices. This must stop for the mortgage securities to stop falling in value. How about a 5 year property tax holiday for all foreclosed houses that are bought? The band aid that is TARP is destined to fail.

[Lazy Fairy]

WAY TO GO FREE MARKETZ!!1!

You're welcome

[Jeff]

Theresa: I'm not advocating that the Treasury should buy the foreign-held paper, I'm pointing out that it's likely to end up doing so, even if it doesn't want to. There is an awful lot of MBS in foreign hands, and if Treasury starts buying the domestic MBS, a lot of the foreign stuff will migrate here and reduce the effectiveness of the bailout.

Actually, I think the whole thing is a very bad idea.

[BoscoH]

Great video interview with Arnold Kling. If there's one guy that might give the House Republicans the testicular fortitude and intellectual firepower to torpedo this disaster, it's him. He has been all over this housing bubble from the start, just like he was all over the Internet bubble back in the day.

A Ch? style image on a T-shirt in Arnold's likeness would be a fitting tribute when this is over.

[ceanf]

yves smith... 'This puts the Treasury's actions beyond the rule of law. This is a financial coup d'etat, with the only limitation the $700 billion balance sheet figure.'

my thoughts exactly. i have been thinking of moving out of the US for this exact reason. problem is, where do you go? in my eyes, the majority of countries in the world are socialist, and the US is not very far behind.

for the first time in my life, i am scared to be an american.

[Douglas Gray]

Current unemployment is more than 6.1%. If the stats are done in a more straightforward and honest way, it is 10-12%. But I agree wait, leave things alone.

[JMR]

A real gold standard and real (free) banking not only haven't been tried, they both inspire great fear and hate in the statists. Look what happened to e-gold & the Liberty dollar (with YOUR tax dollars and YOUR law enforcement/judicial resources) while this fiscal clusterfuck was building. And despite all the resentment and name-calling, "gold bugs" do, at this point, get to say "I told you so." Money matters, and gold & silver are the only REAL money.

[Nash]

"i made NO bad decisions. but my home value and retirement account are being wiped out cuz these assholes destroyed capitalism by figuring out how to pas on their risk to everyone else in the world (i.e. leveraging the hell out of worthless instruments). how can capitalism exist if the risk is divorced from the risk taker and instead dumped on those of us who did nothing? i'll be damned if i'm gonna watch my entire net worth disappear just to save a fucking theory."

Unless you're retiring in the next 5 years your current 401k value isn't THAT relevant. Unless you need to sell your house it's current value also irrelevant.

If you are retiring within 5 years then your money better be in bonds and metals instead of stocks and if it's not you made a poor decision.

Unless you're over 60 please don't follow the government's lead and "do something about this." Keep your retirement fund the way it is.

[Colin]

"Money matters, and gold & silver are the only REAL money."

What? Gold is a ponzi scheme; it doesn't have any value except for the value that people place on it. Its right up there with tulip bulbs.

[Windtell]

I hope that your joking when you comparable tulip bulbs with a durable commodity Colin.

I was going to write more about uses and demand for gold and prices but the first part about sums it up; I hope you're kidding me.

[Colin]

Sadly, I'm not kidding. I am SHOCKED that intelligent people still talk about gold as an appropriate thing to base a financial system on.

[Episiarch]

Money matters, and gold & silver are the only REAL money

Ha ha, so naive. I've said it before: violence is the only true currency. Your gold doesn't mean shit when I kill you and take it.

[Isaac Bartram]

i made NO bad decisions. but my home value and retirement account are being wiped out cuz these assholes destroyed capitalism by figuring out how to pas on their risk to everyone else in the world

If you made "NO bad decisions" then your home and retirement account are worth considerably more than they were when you bought or contributed to them.

Now maybe they've slipped from the wildly inflated values of the nineties and the oughts but frankly I wonder why anyone would expect those to have been guaranteed.

how can capitalism exist if the risk is divorced from the risk taker and instead dumped on those of us who did nothing?

How is this bailout anything but "dump[ing] on those of us who did nothing"?

[Tulpa]

Update: John Bohner and the House Republicans appear to be willing and able to block the Paulson/Bush/Pelosi plan: article here.

[Isaac Bartram]

It seems that solons mail and phone calls are running something like 100:1 against this deal.

Looks like Barney and co need the Republicans to help erect a facade of bipartisanship so the voters won't know who to kick out next month.

[JMR]

Gold, along with brass, isn't a ponzi scheme. It's insurance (given enough brass/lead). Social "Security" is the ponzi.

[Stretch]

Gold is a ponzi scheme;

Gold is a precious metal not a ponzi scheme. Do you even know what that phrase means?

it doesn't have any value except for the value that people place on it.

What do you think money is, exactly? At the very least gold can be used to make things, which is more than you can say for our green slips of paper.

I am SHOCKED that intelligent people still talk about gold as an appropriate thing to base a financial system on.

As opposed to what? We can either use a durable metal highly valued everywhere in the world and throughout all of human history or we can print a lot of pictures of dead presidents and play make believe.

[bornskeptic]

This was a ridiculous article. I looked at many of the economist's backgrounds, and found none that seemed to have any experience at all working in or researching actual capital markets. Such knowledge and experience that they didn't seem to have is essential for one to make a reasonable evaluation of this situation. Heck, you might as well have gathered some small particle physicists around and got their opinions on it. At least if you did that, people wouldn't just assume that they might have extra good ideas about the Paulson plan. Just because someone's and economist, or an anarcho-economist or whatever doesn't imply they know anything about markets.

[Speedmaster]

Way to go, Dr. Munger!

[Theresa Klein]

The root of the problem, as far as the bailout is concerned, is this "too big to fail" notion.

We need to take a serious look at that argument. On the face of it it strikes me as terribly self-serving to the companies claiming they are "too big" to fail, so the government (and by extension society at large) has no choice but to bail them out. Plus we know these companies are intertwined with the politicians who are planning the bailouts, and screaming about financial collapse. So we should be doubly skeptical of those claims.

The argument I suppose is that if they fail, it will cause unacceptable disruption. Okay, I'll but that. However, does that necessarily entail that we should prevent failure entirely? Perhaps what is needed is a better process that allows these institutions to fail in a less disruptive way. I.e. reform of bankruptcy laws, or maybe a new type of bankruptcy that is even less distruptive than chapter 11.

Another argument: The issue isn't so much that these banks are insolvent, it's that they have illiquid assets that investors are panicking over and don't want to buy right now. So they are having a liquidity crisis.

This strikes me as right. The banks would be okay if their assets could be valued correctly. This approach seems to justify the Tresury's approach - buy up the illiquid assets, thus injecting cash into the market, and then value them later and sell them off.

Of course, once these assets are in government hands there's no guarentee anyone is going to want them. Actually, they probably will wash their hands of the mess. Thus leaving the Treasury with billions in assets tied to real-estate all over the country, and a bureaucratic nightmare sorting out the values, which will leave taxpayers effectively subsidizing homeowners who bought mortgages they couldnt afford. I wouldn't be surprised if we ended up with government seizing foreclosed homes and turning them over to HUD. It'll be a disaster.

There are lots of possible alternatives that havn't been looked at. But the Bush administration is trying to rush us into direct aquisition of these paper assets. I can't see how the state is going to do a better job unravelling their value than the private sector.

The proposal by the house Republicans is worth lookign at, but there are other options. I'm not seeing this credit freeze they are warning about, and if it happens, then direct intervention in the form of short term loans might be a better idea than rushing into this huge bailout.

[Ed]

but our fearless leader says we must act immediately!

When has he ever steared us wrong???

[Lee Cruz]

I played this in a tent here in Bagram Afghanistan and jaws dropped:

chrismartenson.com/crashcourse

This blows away anything so succinct as a few simple questions asked by Reason

[voxpo]

bornskeptic | September 26, 2008, 11:23am | # This was a ridiculous article. I looked at many of the economist's backgrounds,...

How many?

[Polywell]

Karl Denninger's ideas are worth a look.

http://tinyurl.com/4ht4ns

[Theresa K]

Polywell, gotta say that I'm with Denninger on anting to fire Bernanke. And Paulsen too.

Boy, if we manage to avoid this disastrous bailout, I hope both their heads are on the chopping block.

[bornskeptic]

Theresa Klein says: | September 26, 2008,

... Of course, once these assets are in government hands there's no guarentee anyone is going to want them. Actually, they probably will wash their hands of the mess. Thus leaving the Treasury with billions in assets tied to real-estate all over the country, ...

Ever hear of the RTC? Tremendous opportunities for buyers were presented as the RTC vomited out real estate and junk bonds acquired from failed S&Ls. Investors will certainly buy, but not if they think there's a reasonable chance that the whole system's going down the crapper.

...There are lots of possible alternatives that havn't been looked at. But the Bush administration is trying to rush us into direct aquisition of these paper assets. I can't see how the state is going to do a better job unravelling their value than the private sector....

Two points here:

1) we don't have an infinite amount of time to consider the best, most opmimal solution - things have been melting down with speed,

2) excuse me, but the private sector is not working right now - that's the whole point of all of this, to get the private sector for capital once again functioning to some reasonable extent.

...I'm not seeing this credit freeze they are warning about...

Ah, let's see, I guess you missed what happened to Bear, Lehman, AIG, Indymac, what almost happened to Goldman and Morgan, and what just happened to WaMu, or what happened to the commercial paper markets last week. If you missed all that, just look at what any credit spreads, CDS levels or money market rates have done over the past couple of months. If you really want to put that in perspective, create some time series of these quantities. If you do that, you will begin to see how whacked out things are right now, as compared to pretty much any other past times where we recorded the data.

[Theresa K]

burnskeptic:
What happened to Bear, Lehman, et. al. wasn't a result of a credit freeze. Nor was it a market failure. Those banks held a lot of bad paper, and went under because of their poor decisions. That's a market success. Business failures are not market failures. Business failures are necessary to keep a normal market functioning and healthy. That's how the crap gets weeded out.

A credit freeze would be a case where banks cease lending to eachother or to ordinary businesses, thus interrupting the normal flow of cash that finances daily operations such as payrolls.

As several people have pointed out, you can still take out a credit card, get a home loan, or an auto loan, and in some cases interest rates have fallen. I'm still getting offers for 0% interest rate credit cards in the mail.

What is going on, it seems to be is an attempt to use the panic on Wall Street - the investors losing billions and frentically calling their frends in congress, to force Socialism down our throats before we realize what is happening.

Hence the eagerness of Democrats to jump on the deal, and the fanning of the flames by the media.

[bornskeptic]

Theresa K:

You have a very simple view of what happened to the various firms that went under. And, you seem to believe the market is functioning as well recently as it has in most other time periods. This is simply not borne out by the facts. And, I hate to break this to you, but it is simply not nearly as easy to get credit now as it was even a few months ago.

[CaesarI]

Chris Dillow is a Free Market Economist how? I hit the blog and he sounds like a Socialist.

[bob]

Does anyone know why my posted comments are now gone? Is this discussion censored to support only the view of a few? Are all the discussions at reason censored in this way?

[Dan K.]

This is the underlying reason for the bailout!

http://www.politicalforum.com/current-events/51926-reasons-market-crash-bailout.html#post831064

[mike]

Why does no one, and I mean no one anywhere or anyplace see the obvious?

Banks are old economy. They have no future. In twenty years there will be no banks, no insurance companies, no mutual funds, no hedge funds. Finally, ten years in the dying, their are no longer any brokerage firms.

New economy will feature markets for all financial instruments. People will have smart programs to invest in those markets. No one will have a 'savings account'

Mortgages will be just another form of investment. Everyone who partakes in these markets will have a reputation -- a detailed record of all transactions. Everything will be a million times more transparent than at present.

This is coming. There is no stopping it short of a reversal of human history and a descent into barbarism.

Why not speed things along and let most banks collapse -- we can have a true credit market up and running in weeks to replace them. If the us government is willing to put up 700 billion to prime the pump of this market banks could become superfluous before the new year.

This is no pie-in-the-sky science fiction dream wish like extended lifespan or true AI. The technology to make this happen exists. The programs to run the markets and deal with individual investment mostly exist and are far less complicated than your average video game.