Some Skeptical Questions About the Bailout
A group of my colleagues and I have been discussing the bailout in email. One of them, impeccably centrist, has raised some fundamental objections to the plan that I wanted to share with a wider audience. With his permission, I reprint them below.
1) The Treasury is proposing to buy assets that no one knows how to value. Perhaps it is a deal like Alaska [aka Seward's Folly], where the government can pick up assets at bargain basement prices from distressed sellers. On this theory, the derivatives (and presumably the underlying mortgages and houses) are worth more than the irrationally fearful market realizes.
But why do we have any reason to believe that the market isn’t valuing these assets correctly? In fact, given the absence of a market for these assets, isn’t their fair market value effectively zero, so that paying anything is overpaying? To my mind, housing is still overpriced, and it sounds to me like the Treasury is planning to pay more for the derivative assets than they are worth.
2) I understand the concern that simply allowing those who hold the derivatives to take their lumps would mean that credit would freeze up (and had frozen up) because of the interlocking credit swaps and other agreements that would trigger the obligation to post additional collateral. But if the problem is credit drying up even for good loans, why wouldn’t it make more sense for the government to make those good loans? Surely it would cost less for the government to make good loans (if they are good loans, the government should make money on them) than to buy apparently worthless assets, no? And if the problem is a cascade of margin calls, why not abrogate (or put a moratorium on) the enforcement of those margin calls?
3) If the real concern is that we need to reassure foreign lenders so that we can keep borrowing from them, it seems to me that we need to stop such borrowing and stop living beyond our means. The Treasury’s plan seems a junkie manuevering for another fix, when what he needs is drug rehab, if not cold turkey. (And what would happen — really — if we simply repudiated foreign debt? Isn’t that where we are headed in the long run if
we continue down our current path?)
4) If the Paulson plan is the best we can do, we can at least attempt to privatize the loss as much as possible by imposing retroactive taxes on those who made money getting us into this mess in the first place. Why shouldn’t the money for the bailout come from those who profited from it?
5) Whenever I hear someone talking about the need to restore confidence to the market, I worry that the market needs — not so much more confidence — but rather more reality. And I recall that we have a name for people who seek to build confidence where it is unwarranted: con men.
I used to think that people running these institutions knew far more about what they were doing than I did. But I am increasingly thinking that they don’t really know what they are doing. . . .
I think these are all fair questions. I’m going to try to discuss more of the distributional implications of the US’s 2 billion dollar a day current account deficit in a future post. For now, we need to realize (as a Nobelist reminds us) that an ungodly amount of American “financial innovation” was little more than a Ponzi Scheme:
America’s financial system failed in its two crucial responsibilities: managing risk and allocating capital. The industry as a whole has not been doing what it should be doing – for instance creating products that help Americans manage critical risks, such as staying in their homes when interest rates rise or house prices fall – and it must now face change in its regulatory structures. Regrettably, many of the worst elements of the US financial system – toxic mortgages and the practices that led to them – were exported to the rest of the world.
It was all done in the name of innovation, and any regulatory initiative was fought away with claims that it would suppress that innovation. They were innovating, all right, but not in ways that made the economy stronger. Some of America’s best and brightest were devoting their talents to getting around standards and regulations designed to ensure the efficiency of the economy and the safety of the banking system. Unfortunately, they were far too successful, and we are all – homeowners, workers, investors, taxpayers – paying the price.