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Economists and the Bailout Revisited:

Co-blogger Eric Posner notes that most economists believe that the bailout passed today is not a good idea, but argues that it is still justified on the grounds that most of them still believe that it is better than nothing. I am not convinced that this is so clear. Summaries of economists' views by Alex Tabarrok, John Lott, and Lynne Kiesling suggest that many of them do not believe that today's bill was better than nothing. As I discussed in this post, I also think that the September 24 letter signed by numerous economists raised categorical objections to the bailout that have not been addressed in later bills. Readers will have to decide for themselves whether my interpretation of the various economists' statements is correct or not. [UPDATE: I'm not claiming that there is a consensus that the bailout is worse than nothing; merely that there isn't a strong consensus the other way].

The more important point, however, is that "bailout or nothing" is a false posing of the alternatives. For what little it's worth, I too believe that "something" should be done; at the very least, I don't know enough to doubt the economists' judgment on that point. It doesn't follow that the bailout was the only available "something." Had it been definitively defeated, political pressure would have grown for alternative remedies, including the "recapitalization" approach that Eric says seems to be the consensus pick of most economists. As Alex Tabarrok points out in the post linked above, "the consensus policy of economists would put most of the burden of adjustment on politically powerful holders of equity and bonds." Not only would this approach be better from a distributional point of view (putting most of the burden of adjustment onto those interest groups that played a big role in bringing on the crisis in the first place). It would also help arrest the slippery slope process towards additional bailouts for other interest groups that the bill passed today is likely to generate. Interest groups would hesitate to lobby for bailouts of their own if they knew that they would have to pay most of the cost of any bailout themselves.

As Lynne Kiesling suggests (here and here), the rush to the bailout may be a classic instance of powerful concentrated interest groups (the finance industry, big investors, possibly other industries hoping for later bailouts of their own), triumphing over a less well-organized general public. If the bailout had been taken off the table, these groups might well have been willing to support alternative proposals to address the crisis that would have placed fewer burdens on the general public and had fewer interest group giveaways attached. Forced to choose between A) letting the crisis continue, and B) recapitalization that they would have to (largely) pay for themselves, the interest groups would likely opt for the latter (assuming that the crisis really is as severe as Eric and others claim, which I think is probably true).

An obvious objection is that any alternative bill would have taken too long to put together. But if Congress was capable of cobbling together the bailout bill within a few days, I don't see why it could not act just as quickly on an alternative - especially given the political pressure for it do so that would have resulted from a definitive defeat of the bailout.

Finally, Eric suggests in his post that the federal government already has the power to impose recapitalization on troubled firms under current law. Indeed, it seems to have already done so in the case of Washington Mutual, which was recapitalized through "speedy bankruptcy" procedures without any significant expenditure of public funds. If Eric is right that the feds already have the power they need under existing laws, to my mind that seems to further undermine the case for the bailout as the only alternative to "doing nothing."

Perhaps none of this matters now that the bailout has passed. However, I still think that it is important for two reasons:

First, it suggests that we should be wary of using the bailout bill as a model for addressing future crises - or future episodes in the current crisis, which may not be over yet. Second, it strengthens the broader case for paying attention to the risks of broad expansions of government power in times of real or perceived emergency. We should not forget the example of the Great Depression, when many harmful policies were imposed in the name of immediate necessity - policies that failed to end the Depression as had been hoped, but did benefit powerful interest groups in ways that often imposed great harm on the general public.

Maybe there is something I am missing here. Certainly, I'm not thrilled about disagreeing with a law and econ scholar of Eric's stature on this question. While I am no expert on the economics of banking, I do know a good deal about the literature on ways in which interest groups and governments take advantage of crises to expand their power. And I fear that this crisis poses a serious danger in that respect. If finance economists across the political spectrum really did believe that the bailout is the best available policy choice or close to it, I wouldn't have anything to say about it. But, as far as I can tell, that doesn't seem to be the case.

Related Posts (on one page):

  1. Economists and the Bailout Revisited:
  2. Do economists oppose the bailout bill?
Charlie (Colorado) (mail):
The extent of my knowledge oc constitutional scholarship is that I've been reading VC for years and years, but I thought the whole point of the constitutional theory Biden and others propounded was that the constitution, properly interpreted, said whatever they damned well thought it said?
10.3.2008 6:48pm
OK lawyer5000 (mail) (www):
As has been said in addressing many other "crises," I will start to believe it is a crisis when those screaming it at me begin to act like it is one. The fact they could not pass this without throwing in all the additional garbage tells me (1) it's not a "crisis" and/or (2) Congress, Paulson, Bernanke and W have no idea what they are talking about.
10.3.2008 7:01pm
TCO:
From: The Base
To: John McCain
Cc: RNC
Bcc: Sarah Palin
Subj: Bail-out

1. Fuck you.

2. Have fun losing the election.
10.3.2008 7:12pm
PC:
As has been said in addressing many other "crises," I will start to believe it is a crisis when those screaming it at me begin to act like it is one.

There was a Rep. on the House floor today that said there was some serious arm twisting going on behind closed doors. Included in that arm twisting were threats of martial law.
10.3.2008 7:40pm
TCO:
And he gave in? Let one of these pussies give me the threat. I'll geld the mother fuckers. Literally. Take it as assault. Ya fucking lawyers.
10.3.2008 7:46pm
TCO:
Ps. I don't believe you, PC. But that's my response in case it was true.
10.3.2008 7:46pm
Glenn W. Bowen (mail):

most of them still believe that it is better than nothing


...but "nothing" was working.
10.3.2008 7:56pm
Anony:

TCO:
Ps. I don't believe you, PC. But that's my response in case it was true.


PC linked to the video. Rep. Sherman definitely said it. Maybe he was lying, but he definitely said it on the floor of the House.
10.3.2008 8:22pm
PC:
Ps. I don't believe you, PC.

It's not me, it's a Rep. that was talking about it. I linked to the CSPAN video of his speech in the House.
10.3.2008 8:23pm
A. Zarkov (mail):
News Flash:

I spoke with one of Sherman's staff and he was unaware of Sherman's statement about martial law.
10.3.2008 8:27pm
ys:
The market dropped precipitously after the bill was passed. That does not sound like a ringing endorsement.
10.3.2008 8:40pm
cboldt (mail):
President Bush would have vetoed any legislation that didn't comport with the scheme (not meant as a pejorative) advocated by his Secretary.
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While other options or solutions are certainly available in theory, in order to pass into law it would have had to obtain 2/3rd majority in Congress to surmount a veto.
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And Congress is generally inclined to avoid making the decision - by adopting what it was given by the President's Secretary, Congress is in a position to disclaim responsibility for the consequences, if they are bad.
10.3.2008 9:02pm
cboldt (mail):
-- The fact they could not pass this without throwing in all the additional garbage --
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The Senate passed "all that garbage" TWICE. Once in the form of H.R.6049, on Sept 23, 2008; and then reinserting the same "garbage" with some amendments, and passing it again (in combination with bailout, in the form of H.R.1424) on October 1st.
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The margin of passage on September 23 (HR 6049) was 93-2.
10.3.2008 9:07pm
Jon Rowe (mail) (www):
I commend libertarians for opposing the bailout, but it seems to me, we free marketers didn't do a good enough job proposing innovative market solutions that could help quell the problem. I propose one here.

The gist:


Automatic American citizenship for any person who buys a house, owned by a bank and previously foreclosed on, after a natural security check of said person. The national security check and payment in full to the bank for the real estate would be the only requirements for American citizenship....1) the dollar is still relatively weak, comparatively, which makes the deal relatively attractive and more affordable. And 2) companies who want to hire educated immigrant workers would be permitted to buy houses (perhaps with tax incentives) for and on behalf of their workers and award them as compensation, holding the "mortgages" for so many periods until the immigrant workers' full rights in the said real estate vest....American businesses and Universities, who would buy the houses and hold the mortgages on behalf of the immigrants, further, could help "drain the brains" from places like China and India whose rapid growth puts the fear of God into some experts that they soon one day will overtake America's dominant economic might.

So what's wrong with this idea?
10.3.2008 9:14pm
Obvious (mail):
I wish there were some way to address the gross asymmetry in the bill process. As things stand now, a bill is introduced and goes down to defeat. No problem; its advocates simply add enough sweeteners, earmarks, etc. (things which make a bad bill WORSE), and present it again. Does it still fail? No problem, simply add more special interest temptations and try, try again.

BUT IF IT ONCE PASSES, we're done. You can't offer a bill that solely has the effect of eliminating a recently passed bill. (Is this technically impossible or simply never done; I can understand the dynamics that would make it extremely unpopular.)

The same thing happens on the local level--light rail comes to mind. Fails, try again, fails, try again, passes, ALLOCATE THE MONEY, then it can't be withdrawn.

It would seem reasonable to have a policy where once something fails there's a time limit that must pass before it is brought up again!
10.3.2008 9:31pm
cboldt (mail):
-- I wish there were some way to address the gross asymmetry in the bill process. As things stand now, a bill is introduced and goes down to defeat. No problem; its advocates simply add enough sweeteners, earmarks, etc. (things which make a bad bill WORSE), and present it again. Does it still fail? No problem, simply add more special interest temptations and try, try again. --
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That paradigm works better in a unicameral or one-shot system, but it doesn't fit the fact pattern of what went down with the bailout.
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The House and Senate passed the pork, sweeteners, whatever you want to call it, in generally this sequence: The House passed HR 6049 in May, 2008 and sent it to the Senate. The Senate larded up HR 6049 with more pork, and passed it 93-2 on September 23rd. It sent that amended version to the House. The House was going to kill the bill by inaction, because it objected to certain tax measures not having corresponding tax increases - I'm doing this from memory, but I think the difference of opinion was either on some "ax extender" measure, or on "how to pay for adjusting AMT." At any rate, all that pork was sitting in the House, ripe for passage if DEM leadership took it up.
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Separately (at least for a time), the House passed a bailout, but the House-passed bailout was really the result of intercameral and administration negotiations in a back room. One could see Senators Gregg and Dodd in the background when the so-called "House language" for the bailout was introduced on Saturday or Sunday. The House rejected it by the narrowest of margins.
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The House and Senate leaders again went to the back rooms, and decided to combine HR 6049 and the bailout - Lord only know what the rationale or trade-offs were, but I don't see it as a "pork for bailout" trade, because the pork was already there for the taking - except it would have taken a few days to negotiate the differences if that bill had gone through the usual House amendment, Senate amendment process.
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I think the political parties were close to agreement on both bills (remember the Senate passed the pork 93-2), and just took advantage of the opportunity presented by the "must pass" bailout to also adjust and pass HR 6049.
10.3.2008 9:44pm
cboldt (mail):
-- Separately (at least for a time), the House passed a bailout, but the House-passed bailout... --
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those should be House-rejected, not House-passed. Sorry about that. Probably numerous other errors, I hope my gist can be ascertained in spite of my slop.
10.3.2008 9:47pm
keithwaters (mail):
One of the objections to the alternatives is that they would take too long to put together. Were you aware that under FDR a bill was introduced into Congress and signed the same day? It may have been on the first day of the presidency but I don't remember.
10.3.2008 10:16pm
MarkField (mail):
cboldt, that's a fascinating sequence. Thanks very much for reporting it.
10.3.2008 10:49pm
Mac (mail):

those should be House-rejected, not House-passed.




cboldt,

Thank you. I was scratching my head wondering if I was in an alternate universe or something?
10.3.2008 11:58pm
Mac (mail):
Listening to Jeff Shadegg (sp?) a very upstanding Representative from here in AZ., Paulson could not have done this worse. The House may not like to make decisions, but you don't come in, say take this, period and then go public 5 hours later screaming that the sky in falling.

I wish he would have met with Congressional leaders of both parties and rounded up Buffet, Grasso and others who do know what they are talking about and done some brainstorming. I know, never would they study something before acting.

I have heard the idea floated that the Government could have, should have bought preferred stock in these companies instead of the bailout. Then, the folks who know what they are doing a lot more than Gov. bureaucrats would be responsible for fixing the mess, but would have the liquidity they need.

Of course, they had to suspend mark to market, which they did. Bad idea on Congress' part to start with.
10.4.2008 12:06am
Mac (mail):
Does anyone have a clue exactly how this is going to work and how much we taxpayers are paying on the dollar for these bad mortgages?


How do we get our money back, let alone make a profit?

I don't really get how this is going to be done. How Buffet is doing it, I comprehend. This I don't.
10.4.2008 12:08am
Mac (mail):
Does everyone realize the mental health provision is going to cost billions?

I thought we wanted to insure more people? Making health insurance a lot more expensive, doesn't seem to be the way to do it.

Some states, Florida is one, I think, are offering bare bones plans and they are very successful, I understand. At least, they seem to be good ideas so far. Does this mean the states who are experimenting with this will have to include mental health benefits to the stripped down plans they are offering?

I have nothing against mental health. However, there are a lot of "fuzzy" diseases that can be used to bilk the system for a bunch of money. I really don't like having something this extraordinarily expensive passed in this manner.

FDIC, I am all for. Just wish is was permanent.

Wooden arrows" Hey, my son was a Boy Scout and it does seem that is righting a wrong.

The rum, I don't get.

What did American Samoa get from this?

What all else is in this bill, I wonder?
10.4.2008 12:17am
Elliot123 (mail):
"How do we get our money back, let alone make a profit?"

The feds will be buying interest bearing securities. They will collect the interest payments while they hold the securities. They intend to sell them back into the market at a later date. If they sell them back for more than they paid, they make a profit. If they sell them back for less than they paid, they take a loss.

Something to watch out for is what happens to the proceeds from the sales back to the market. Last I saw, the profits had to be used to pay down debt, but I'm not sure where the recapture of the initial purchase amount goes.

It is possible the feds will recoup all the money they spend, and Congress will then grab that money and spend it on day care, health care, and rain forests in Idaho.
10.4.2008 12:21am
Kurmudge (mail):
There are multiple ways to recapitalize banks, and there are myriad advantages and disadvantages to each. There is nothing more inherently evil about Paulson's plan than about the "economist plan". In fact, I still have not seen a good argument why the US government buy stock directly in banks is "more libertarian" or free market than simply buying the bad paper and reselling it at some point.

This sounds to me more like pointless whining over the fact that any intervention is deemed to be necessary at all, since the markets will sort it all out eventually. To me that sounds a lot like being angry that the patient caught pneumonia, so we will refuse to administer antibiotics or hydration.

There is a problem. It needs to be addressed. The laissez faire approach we all prefer would eventually restore equilibrium, but there are a lot of us who believe that the likely collateral damage is unacceptable. We probably don't have the time we all wish we had to work this out. The chain reaction is hard to stop once you let it start.

I guess that reality ensures that I am becoming less purist every day due to political reality. Sometimes you have to take a vaguely acceptable approach to action- and maintain vigilance with the execution- because you realize that there are no good alternatives, just bad and less bad.

Chill out, gang. And stop talking about "bailout' as though the assets are zero cents on the dollar rather than 60 cents on the dollar, with likely appreciationm over time.
10.4.2008 12:43am
Mac (mail):
Elliot123 wrote,(mail):
"How do we get our money back, let alone make a profit?"


The feds will be buying interest bearing securities.


OK. But we are told there is "toxic" debt. I assume they are talking about mortgages that are in default or of homes that have been foreclosed on. Is that wrong?

Someone is going to get stuck with the mortgages that are in default and the homes that have been foreclosed on and that can't be sold for anything like the purchase price or even the mortgage. Somebody gets stuck. Who? If it the banks, then how does the bailout or whatever you call it, help?

I have also heard that bad car loans and credit card debt is included in this. Is that true, does anyone know?
10.4.2008 1:27am
Elliot123 (mail):
"OK. But we are told there is "toxic" debt. I assume they are talking about mortgages that are in default or of homes that have been foreclosed on. Is that wrong?"

The term "toxic debt" doesn't do us much good, since there is no standard definition for it. Some say it is a loan for which there is no market. Others say it is a junior tranche of a bundle. Others say it is a loan in default.

Mortgages that are in default are not valueless. The stream of payments has stopped, but the house is still standing there. It will be sold, and the sales price will flow to the mortgage holder. The sales price may be less then the mortgage, but we have to look at each case to determine the situation. There is no reason to presume the feds will pay the initial value of the mortgage.

It is possible they will pay more than the eventual sale price and take a loss. It is possible they will pay less than the eventual sale price and make a profit.

(We have to remember that individual mortgages are not being traded; they are in bundles, and in derivatives of bundles. But the concept is easier to understnad with a simple example.)
10.4.2008 1:49am
TCO:
There are lots of things more inherently evil about Paulson plan than bankruptcies. For one thing, the wealth transfer from taxpayers to trading company losers.

BTW, it is not "banks" that are being saved, at least in the sense of commercial banks. But trading companies, counterparties to trades (hedge funds), overseas investors, etc.
10.4.2008 9:04am
Minotauro (mail):
The public got rolled on this bailout.
10.4.2008 9:49am
PubliusFL:
Someone really needs to get to the bottom of that Sherman statement about martial law. That's just inexcusable.
10.4.2008 10:21am
Lily (mail):
Why do we give our government so much power? Why do we trust such people with our money and our future?

The long term solution is much less government. Take back your power and money. And throw the current pols out of office. Expect more from yourself, and less from elected officials.

And never forget - this was not a 'failure of the market system'. The government interfered with the market for 'socially correct' reasons.
10.4.2008 10:23am
Ken Arromdee:
2) companies who want to hire educated immigrant workers would be permitted to buy houses (perhaps with tax incentives) for and on behalf of their workers and award them as compensation, holding the "mortgages" for so many periods until the immigrant workers' full rights in the said real estate vest..

That means that the workers are stuck working with that company and can't change jobs. In other words, you're adding more fuel to the same problem that using H1Bs in the computer industry has right now.

It's also not free market. For the government to selectively do something otherwise free-market isn't free market; selling houses but only to immigrants and companies hiring them is no more free market than selling houses only to millionaires, or only to left-handed people.
10.4.2008 12:42pm
elim:
so, the Great Depression II was avoided yesterday and the stock market went down 150+ points-almost like everyone knows it was a charade? (and now know that every downturn in some indicator never previously cited in public will lead to calls for more money).
10.4.2008 1:14pm
Hanging Party:
Dear Representative:

Last Friday, you voted a $700 billion dollar severance package for the outgoing Bush administration. Now, what do you plan to do about the economy?

You may be able to put off “Bailout 2.0” until after the election. But economists expect that “Bailout 2.0” will be urgently needed before January. What do you intend to do? And how do you plan to pay for it?
10.4.2008 1:16pm
Gordon (mail):
P J O'Rourk said it ( I assume) second, Parliament of Whores!
10.4.2008 3:16pm
TheWhaler (mail):
You write:

"Maybe there is something I am missing here. Certainly, I'm not thrilled about disagreeing with a law and econ scholar of Eric's stature on this question."

What kind of peer-review servility is this? Are you looking for a credentialist pat on the head? Friendship is opposition! Attack! Attack! With courage that attacks, courage that destroys.
10.4.2008 4:23pm
rfg:
The point of the package was to help the poor, stuggling institutions stuck with credit-defaut-swaps and all other sorts of complex financial instruments that they did not understand and did not want to deal with anymore. This threatened the system so much that they had to be helped.

Everyone else can just suffer.
10.4.2008 10:15pm
Jon Roland (mail) (www):
The Origination Clause Art. I Sec. 7 Cl. 1 reads:

All Bills for raising Revenue shall originate in the House of Representatives; but the Senate may propose or concur with Amendments as on other Bills.

Question for the forum: Did the Mortgage Bailout process violate this provision?

According to the Senate site, the official name of the bill passed by the Senate was an "amendment" to H.R. 1424 Bill Title: The Paul Wellstone Mental Health and Addiction Equity Act of 2007.

But the bill passed by the House was H.R. 3997 Bill Title: To amend the Internal Revenue Code of 1986 to provide earnings assistance and tax relief to members of the uniformed services, volunteer firefighters, and Peace Corps volunteers, and for other purposes

If it did not violate the Origination Clause, then explain how it complied with it.
10.5.2008 2:15pm