Thinking the bailout through
What is this bailout supposed to do? Will it actually serve the purpose? What should we be doing instead? Let’s talk.
First, a capsule analysis of the crisis.
1. It all starts with the bursting of the housing bubble. This has led to sharply increased rates of default and foreclosure, which has led to large losses on mortgage-backed securities.
2. The losses in MBS, in turn, have left the financial system undercapitalized — doubly so, because levels of leverage that were previously considered acceptable are no longer OK.
3. The financial system, in its efforts to deleverage, is contracting credit, placing everyone who depends on credit under strain.
4. There’s also, to some extent, a vicious circle of deleveraging: as financial firms try to contract their balance sheets, they drive down the prices of assets, further reducing capital and forcing more deleveraging.
So where in this process does the Temporary Asset Relief Plan offer any, well, relief? The answer is that it possibly offers some respite in stage 4: the Treasury steps in to buy assets that the financial system is trying to sell, thereby hopefully mitigating the downward spiral of asset prices.
But the more I think about this, the more skeptical I get about the extent to which it’s a solution. Problems:
(a) Although the problem starts with mortgage-backed securities, the range of assets whose prices are being driven down by deleveraging is much broader than MBS. So this only cuts off, at most, part of the vicious circle.
(b) Anyway, the vicious circle aspect is only part of the larger problem, and arguably not the most important part. Even without panic asset selling, the financial system would be seriously undercapitalized, causing a credit crunch — and this plan does nothing to address that.
Or I should say, the plan does nothing to address the lack of capital unless the Treasury overpays for assets. And if that’s the real plan, Congress has every right to balk.
So what should be done? Well, let’s think about how, until Paulson hit the panic button, the private sector was supposed to work this out: financial firms were supposed to recapitalize, bringing in outside investors to bulk up their capital base. That is, the private sector was supposed to cut off the problem at stage 2.
It now appears that isn’t happening, and public intervention is needed. But in that case, shouldn’t the public intervention also be at stage 2 — that is, shouldn’t it take the form of public injections of capital, in return for a stake in the upside?
Let’s not be railroaded into accepting an enormously expensive plan that doesn’t seem to address the real problem.
If our regular discourse looked like this, I’m pretty sure we would have never ended up with this mess.
Actually, a couple of very interesting examples of false balance. Back in the day – and no one remembers – but back in 2003, New York had an [LAUGHS] attorney general named Eliot Spitzer. And he was going to war with the comptroller of the currency, and the war was over whether or not New York State anti-predatory lending laws could apply to nationally chartered banks.
What happened was that almost all the states’ attorneys-general picked up on this issue – and this is 2003, 2004 [LAUGHS], 2005 – and they’re seeking to rein in nationally chartered banks and their lending practices in the subprime category.
The press, predictably, and kind of shamefully, I think, treated this as some sort of ping-pong match between Eliot Spitzer and the Bush Administration. I’m telling you, beneath the fight between officials there were a lot of signs that something was sort of rotten going on between lenders and borrowers. That’s a pretty good, you know, sort of smoke signal to the press to go out and explore the issue more deeply, and they really didn’t.
[Tags]Financial Meltdown, Planet Money, Paul Krugman, On the Media, Economics, Media, Podcasts[/Tags]
