Bailout Analogy:

I've been thinking about co-conspirator Eric Posner's analogy (see chained post) in regard to the recent Treasury Dep't moves in the banking bailout:

It is now clear that Treasury will take a more aggressive approach. Not only will it buy commercial paper; it will buy equity in banks. . . . People call this process "restoring confidence" in the financial system; but it really just replaces one financial system (a more-or-less private one) with another (a government-run system). It's as if a hurricane hit a city and the national guard took over food distribution. We don't say that the government is restoring confidence in the private food distribution system; we say that it is operating the food distribution system, and will do so until the private system recovers on its own. (my emphases)

Is the food distribution analogy the right one here? There is a difference between buying equity in banks [or food distribution companies] and sending out the national guard to do our banking/food distribution work. Among other things, we (i.e., the Treasury) participates in the upside (if there is an upside) in the one and not in the other. And more to Eric's point: it is not quite as absurd to call the former a "confidence restoring" move. Warren Buffett's purchase of Goldman Sachs equity was widely seen (correctly, imho) as a move that could "restore confidence" in Goldman, because buying equity is very stupid if the firm is going into bankruptcy but very smart if the firm is going to recover. The Treasury plan is not exactly the same, I realize, but calling it a move that might "restore confidence" in the banks doesn't strike me as so terribly over-the-top.

Related Posts (on one page):

  1. Bailout Analogy:
  2. Plan B (C?).
Uh, Warren Buffett's purchase of Goldman Sachs equity restored some confidence because most people (correctly, imho) is that Buffett is widely regard as a wise judge of economic value. The Treasury is not regarded that way.
10.9.2008 6:32pm
Random thoughts from an enquiring mind:

1. If the TED Spread is over 4 and the base money supply chart has become a vertical line, does the Constitution still apply?

2. Will Yom Kippur be moved to a day when U.S. markets are closed?

3. Will the habeas cases be mooted out after the federal government misses payroll and the judges leave?

4. How much vacation will Mr. Buffett allow for new hires?

5. Who will now admit that he or she (a) thought the repeal of Glass-Steagall was a bitchin' idea, (b) once voted for George W. Bush, (c) thought Alan Greenspan was a scary genius, or (d) all of the above?
10.9.2008 7:11pm
Actually, the Treasury very much restores confidence by investing in banks. It worked quite well with the Net Worth Certificate Program back in the 80s.
10.9.2008 7:19pm
I see major differences between the analogy and the Treasury buying equity positions in private companies.

First, in the hurricane relief setting, the National Guard is generally acting in a state, not federal, capacity. So, if they screw up too much, you can call local leaders to get the problems addressed.

Second, the National Guard, whether acting in a state or federal capacity, has a clear chain of command, and its Soldiers are not protected by civil service protections. So, if there's a screw up, effective corrective action is more likely to be quickly taken.

Third, if the National Guard screws up food distribution in a city, you have the option of going some place else. Here, if (or more likely, when) the US Treasury screws up, moving won't avoid having to face the consequences.

Finally, if anything should have been learned from what's known about Fannie Mae and Freddie Mac, it's that politicians cannot resist meddling with financial institutions to please special interests or get campaign contributions. Why would different conduct be expected in the future as to any business in which the US acquires an equity position?
10.9.2008 7:24pm
John Jenkins (mail):
1. The repeal of Glass Steagall was and is a good idea, and if you can explain how allowing commercial banks to own investment banks has caused any harm, I'd love to hear it. Actual data would be nice, but I'd settle for cogent argument at this point.

2. David Post's analogy to Warren Buffett doesn't work. The reason Buffett's investment might have restored confidence in Goldman is twofold (1) as noted above, Buffett is widely acknowledged as a wise investor; and (2) Buffett is RISKING SOMETHING. Treasury's gamble is with other people's money, thus it should have no effect on anyone else's analysis, since there is no risk to the treasury folks if they screw up. In fact, we all *expect* them to screw up. The question is not whether they will lose any money, but only how much.
10.9.2008 7:35pm
The big difference is that food distribution is an emergency measure, with a take it or leave it selection system. Nobody thinks that government cheese, surplus freeze dried mashed potatoes or whatever else is left over from the surplus food stockpile is going to provide a long term substitute for Whole Foods, or even Safeway. They are inferior goods, that there is no long term market for.

If we could get our mortgages and credit cards from the government that of course would be a long term substitute for private credit markets because it wouldn't be long before congressmen were proposing debt holidays and interest rebates in order to buy votes for the next election. That of course would make government loans a superior good that would crowd out private lending. I can hardly wait.

Of course what is actually proposed is private lenders relying on government capital, which should provide higher margins for the lenders, again crowding out private sources of capital. Either way, it is unlikely to be a short term intervention.
10.9.2008 7:46pm
James Gibson (mail):
All I note on this is what the people I work around have noted; that we (the public) and the candidates (Obama and McCain) are talking more about the bail-out then Reid, Pelosi, and virtually everyone else who voted for it in the Congress and Senate. The only recent comment from Pelosi I have seen is her call for an additional 150 Billion for a stimulus package (even though she has already called the 700 billion a huge number).

Why do I get the feeling we just threw good money after bad!
10.9.2008 8:00pm
Is the food distribution analogy the right one here?
Analogies are like rubber bands. If you stretch them far enough, they break.

One analogy I think might work, because it tends to have several mini-analogies embedded, is government takeover of fuel markets and distribution.

The hypo: natural cataclysms, combined with internal technical problems, including contaminated fuel, in oil production, refining, markets and shipping, causes massive fuel shortages. Government (correctly or not) decides that a some takeover of wells, refineries and shipping is necessary to restore orderly fuel availability.

Without fuel reasonably available, to some extent regardless of price, the economy can't function, because people can't get to work, utilities can't produce electricity, people freeze in the dark, etc.

With some semblance of order in fuel markets and distribution, the economy can at least stagger along and possibly recover.

The questions in the analogy are about the same as the actual situation with financial institutions:

Can the government restore sufficient order to the markets that the economy doesn't entirely collapse along with major private institutions?

If order is restored, can and will government step aside and return the market to some set of private hands, not necessarily the same hands it took over?
10.9.2008 8:16pm
vinnie (mail):
I don't know about the restore part but Im pretty sure of the confidence part.
10.9.2008 8:25pm
Perhaps there is another reason why the hurricane analogy is not the best.

When the National Guard takes over food distribution, it is acting to fill a function that, because of the disaster, cannot be performed by private actors. Without government action, food would [arguably] not be delivered.

When the Treasury takes over the financial sector, it is not acting to fill a function that would otherwise go unperformed by private actors (at least according to many economists). Rather, the government steps in to cure the perception that the private firms are unable to do the job and adequately keep credit markets moving. The difference stems from the market's heavy reliance on expectations: a "disaster" can arise simply by people imagining there is one. Quite simply, you can't imagine the hurricane that destroys the food distribution system.

Or, maybe expectations have nothing to do with it. I suppose it all depends on what economic model you adopt.
10.9.2008 9:43pm
Michael B (mail):
Providing truly meaningful analogies for such matters requires something akin to an aphoristic penetration and depth. I've yet to read one good, truly applicable and sufficient analogy that comes to terms with this situation.
10.9.2008 9:54pm
Vermando (mail) (www):
Odd he would choose that analogy given that, indeed, the government often does take over the provision of food in emergency situations, as anyone from south Louisiana or Texas can attest.
10.9.2008 9:59pm
When government takes over to restore confidence, there needs to be confidence in the government's competence. I, for one, do not have that confidence. How many people do?
10.9.2008 10:48pm
Alan Gunn (mail):
As I understand it, the point of Professor Posner's post was that the government seems to be getting itself into activities it isn't competent to handle. The analogy came in only as a way of illustrating that the government's rhetoric was misleading. Do you disagree with that? Does it really matter that the cases of banking and food distribution differ in some ways? Analogies say "A is like B," not "A is identical to B." The differences you suggest between food distribution and banking are real, but what have they to do with the point the analogy was used to make?
10.9.2008 11:14pm
Maybe a better analogy would be nationalizing the steel industry after it effectively shut down because of labor unrest?

oops... I seem to recall SCOTUS had something to say about sort of behavior that when Truman tried it. Hmmm...
10.10.2008 6:18pm