Sat Sep 27th, 2008 at 10:50:03 PM EST
The Johns Hopkins economist Christopher Carroll has an interesting blog entry describing rescue plan which has been proposed by economists which is better than Paulson's, and expressing puzzlement about why this alternate plan has been completely ignored in Washington. This plan involves temporary nationalization, something that was done by Sweden when it had a financial crisis in 1992.
In talking to people involved in the inside-baseball political side of the discussion on Capitol Hill, I get the impression that they are very unhappy about being asked to sign on to this bill, but are planning to do it because they have been told that if they don't sign on the dotted line then the apocalypse is around the corner.
The KEY point that I think is not penetrating from the economists to the Congress is that what sticks in our craw is ONE SPECIFIC ASPECT of the Paulson/Frank plan: Its focus on having the government buy up the toxic subprime securities. This is close to a pure bailout for Wall Street, and there is NO REASON that any of us sees that this has to be the core of the rescue plan. I think you could get near-unanimity from economists, from across the political spectrum, in FAVOR of a simple, easy-to-do alternative that would be both more economically sound and more politically palatable: The Federal government should do, with respect to the banking sector as a whole, what Warren Buffett did last week in his investment in Goldman Sachs.
Buffett did not become the richest man in the world by making bad investments. The money he provided to Goldman was emphatically NOT a bailout. It was a prudent investment - he thinks he will make his money back, and much more. The taxpayer should follow his lead and take a similar stake in the financial industry.
This is the essence of the concrete plans that conservative, moderate, and liberal economists have been proposing (cf. Zingales and deLong). I think the reason these ideas have not made more headway on Capitol Hill is simply that the proposals are written in terms that are too technical for members to realize that they are all basically saying the same thing: The right way to recapitalize the financial system is by investing money in the system as a whole, so that the taxpayer benefits when the economy recovers. This is not a new idea; it is basically what Sweden did in 1992 when it faced a financial meltdown, and it worked out OK in the end for the Swedish taxpayer (at least compared with the alternatives). Just like Warren Buffett, the taxpayer might even ultimately make money on the deal.
At the risk of making eyes glaze over, let me sketch one way of doing this (which is basically similar to the more concrete and detailed proposals of others): The taxpayer could approach each financial institution that is in trouble and offer them a take-it-or-leave it deal: You need capital and we have capital. We'll either lend you the money you need (in exchange for being first in line for repayment out of any future profits, and in exchange for your cutting your dividends to zero until your capital is restored), or we'll buy preferred shares in you in an amount directly proportional to shareholder equity from your last audited financial statement (again, you must cut dividends to zero until you are healthy again). This solution is not perfect, but I am assured by people who should know that it is something that could be organized very quickly and would provide the needed capital. The plan would need to specify, in an ironclad way, that the taxpayer's stake would be sold off (at a profit) when the system regains its footing.
Carroll offers an explanation for why this plan is not getting any traction in Washington (the Republicans proposed an alternative plan, but not the Democrats!):
What is mystifying to me and many other economists is why there seems to be such resistance to the Zingales/deLong/Buffett plan by people who do not seem to be able to offer a coherent rational argument for why it would not work, and an insistence instead that the taxpayer should buy the toxic assets directly. I can think of only one potential explanation: A rigid ideological opposition on the part of Henry Paulson to taxpayer ownership of even one dime of the financial sector. If this is the right explanation, it is scarily reminiscent of the rigid ideologies that led to catastrophic errors of policy judgment during the Great Depression. A lot of conservative economists, who share Paulson's presumed predilictions in this regard, have seen the light and now feel that the Zingales/deLong/Buffett plan is the best of a bad set of options. Why doesn't Henry Paulson agree?
(I should note, in fairness, that Paulson has moved somewhat in this direction; the latest versions of his plan involve taxpayers getting some ownership stake in exchange for their purchases of the toxic assets. But if he is willing to compromise in that regard, it is all the more mysterious that there is still an insistence on buying the toxic assets).
Why Washington wants to buy the toxic assets even though this is not required to get the financial sector back in order is obvious to anyone but an economist. Economists, like other American social scientists, do not as a rule progress beyond the view of the role of the US government that we get taught in grade school: that its purpose is to serve the American public. As we have seen all too well in the last eight years, its real role is to plunder other people's wealth to transfer it to the very wealthy (see Free Lunch). And this is precisely what the Paulson plan does, on a massive scale (without solving either the problem of the undercapitalization of banks or that many houses are now worth less than the mortgages taken out to buy them).
The purpose of the Paulson plan is not to rescue the financial sector—a later plan developed by the next administration will have to do that—but to rescue the paper gains that very wealthy investors had made which have recently disappeared.
It's possible that Carroll is using snark when he says it is "mysterious" that there is "an insistence on buying the toxic assets", but I don't think he is. Also, he doesn't mention that Buffett supports Paulson's plan. Evidently, Buffett doesn't find that what's good for Buffett is good for the American people.
It's also interesting that in an interview with the progressive radio talk show host Amy Goodman, Paul Krugman says that "temporary nationalization in a financial emergency is always the way to go, but the word "nationalization" nowhere appears in his column of the same day. Krugman is a bit more specific in his latest blog post:
Nouriel Roubini has a characteristically scathing takedown of the Paulson plan, and here's the thing: language aside, his economic analysis is similar to mine. The fundamental problem in the financial system is too little capital; bizarrely, the Treasury chose not to address that problem directly, by (say) purchasing preferred shares in financial institutions. Instead, the plan is premised on the belief that toxic mortgage-related waste is underpriced, and that the Treasury can recapitalize banks on the cheap by fixing the markets' error.
The Dodd-Frank changes make the plan less awful, mainly by creating an equity stake. Essentially, this makes it possible for the plan to do the right thing through the back door: use toxic-waste purchases to acquire equity, and hence inject capital after all. Also, the oversight means that Treasury can be prevented from making the plan a pure gift to financial evildoers. But it's still not a good plan.
Carroll finds it "mystifying"; Krugman finds it "bizarre". Mentioning the obvious explanation is out of the question if you write for a corporate news outlet or have an academic job.
Update [2008-9-28 16:14:0 by Alexander]: Now that a deal's been reached, Krugman finally says what other economists have been saying:
Brad DeLong says that Swedish-style temporary nationalization is the right answer to a financial crisis; heís right. I havenít been clear enough about this, it seems, but itís where my basic diagnosis leads: the problem is insufficient capital, you want to inject capital, but you donít want it to be a windfall to existing stockholders ó hence, take over and recapitalize the failing firms. By the way, thatís what we did with AIG 10 years days ago.
So thatís the good solution. The Paulson plan, which is some combination of sheer giveaway and mystic faith that a slap in the marketís face will make everything OK, is a bad solution (and probably no solution at all.)
And note that he writes "Brad DeLong says". It's not just DeLong: it's virtually all economists. But Krugman is afraid to point that out, because then his readers would start wondering why Congress would approve of a plan that essentially all economists agree is bad and probably won't work. By making it seem that it's just he and DeLong who think it's a bad plan, Krugman sticks to the media's postmodern narrative mode according to which there are just differing points of view.