Thursday, October 02, 2008

Economists battle over the bailout plan

[Sept. 26] Yesterday's White House meeting didn't go according to plan. Senator Richard Shelby (R-AL), the ranking Republican on Senate Banking, emerged a little after 5 p.m. to declare "There is no agreement" and that the Paulson Plan wouldn't work. He waived objections signed by 192 prominent economists.... [CG&G]
If the danger posed by the financial crisis is so clear and present, why can't the economists of the world agree on what to do about it?

Bruce Bartlett explains how the financial sector is fundamentally different than the other sectors of the economy, critical to the functioning of the rest, and says it must be saved rather than risk that it collapse like "a house of cards" and bring the rest of the economy down with it. It's the 1930s all over again. "Failure of this plan risks another Great Depression. Really."

Casey Mulligan tell us just the opposite. He says in substance that the rest of the economy today is hugely larger and more productive relative to "Wall Street" than it was in the 1930s, that its performance today is largely independent of Wall Street's. He says that if Wall Street goes down it will go down alone, and the government bailing it out will only make matters worse. "The Treasury and the Fed should let Wall Street drown alone, to be replaced by new financial service providers who can swim as robustly as non-financial American businesses."

Bartlett's piece gives a very good, plain-English explanation of what actually happened in the 1930s, and is well worth reading whatever your opinion of the bailout proposal to understand the thinking (and fears) behind it.

But Mulligan is saying that an awful lot has changed since the early 1930s -- and he has a point too.

The bailout has been protested by those 192 petition-signing economists -- but that doesn't mean as many or more who haven't put a petition together don't support it. (Petition signers usually are a mobilizing minority.) The economists on my blogroll in the left column of this page are pretty much split over it, some taking strident positions.

The problems are insufficient information and lack of time. Thing are happening rapidly -- huge unexpected events literally in a day. Nobody knows the true extent of the risk in an extremely complex situation, and nobody has the time to perform a comprehensive analysis to figure it out.

The two people who undoubtedly know more than anyone else about what's going on are Bernanke at the Fed and Paulson at Treasury. When they let Lehman Brothers go into normal bankruptcy and then wagged their fingers at everybody saying "That's it, you all, there'll be no more government money for anybody else!", they pretty clearly thought they had the situation contained. Well, that lasted a little more than one day until they saw AIG about to go down. So even they don't really know what's going on, which means nobody does.

Since nobody knows who's right, that leaves us in the position of having to compare the relative cost of being wrong.

If we follow Bartlett's advice and he's wrong, we needlessly force taxpayers to pony up money (how much, a little or a lot, remains very uncertain) and get a financial sector made less efficient by the government's regulators and Congress pushing their fingers through it and politically manipulating it in countless assorted ways, while financial firms that deserved to die on the merits live on at the expense of the rest of us.

If we follow Mulligan's advice and he's wrong, we needlessly get millions of people unemployed, and the other financially vulnerable losing their savings and many of their homes and being pushed into financial hardship en masse.

Pick your poison.