Co-blogger Eric Posner argues that today's decline in the stock market proves that the bailout would have been worth the cost:

Ilya and Casey [Mulligan] say that the bailout was just a transfer of wealth from taxpayers to shareholders. Maybe. But most taxpayers are shareholders, and the return seems pretty good. Even if we confine ourselves to the U.S. stock market, a return of $800 billion on an investment of $700 billion (actually, a lot less, given that money is used to purchase assets that will eventually be sold again even if at a loss) is not bad. If we count the world's $2.5 trillion, the return is quite excellent. (I realize this is not a controlled experiment, but we have to use whatever information is available. As Ilya hints, he can salvage his theory by arguing that the failure of the bill tells shareholders that subsequent bailout bills, spending even more money, are less likely than before.)

I continue to disagree, for several reasons.

First, as I noted in my original post, past stock market crashes show that the real economy isn't necessarily damaged as a result and can in fact rebound quickly if no harmful policies are adopted to prevent it. To use today's fall in stock values as an indicator of the costs and benefits of the bailout is similar to claiming that the similar 7% loss in stock value when markets first reopened after 9/11 was an accurate measure of the economic impact of that attack - while ignoring that the economy (and stocks) did well thereafter, soon recovering the loss. Sudden stock market shocks caused by uncertainty, disappointment (in this case, disappointment that stockholders won't get an expected bailout), and fear are not a good measure of longterm impact on an economy.

Second, as Eric suggests, I do indeed worry that the bailout would have caused other bailouts and government interventions that would put us on a path to significantly lower growth in the future. That really would damage the overall economy in a way that a sudden drop in stock prices doesn't.

Finally, much of the fall in stock prices may be due to the market devaluing assets (e.g. - bad mortgages) that had been overvalued previously. The bailout might have prevented or reduced such reconsideration because it would have artificially propped up the value of these overpriced assets by buying many of them up with taxpayer funds. More accurate pricing of assets is good for long-run economic growth and is likely to enhance our wealth, not reduce it. By pricing these bad assets more accurately, the market can facilitate the transfer of capital to other, better uses, making us richer in the long run.

UPDATE: I also respectfully disagree with Eric's claim that "Nearly every knowledgeable person supported the bill -- in the sense of believing that the bill was better than nothing, even if he or she believed that some variation would be even better than the actual bill." A recent petition signed by over 190 prominent economists from across the political spectrum stated that the bailout plan "is a subsidy to investors at taxpayers' expense. Investors who took risks to earn profits must also bear the losses. Not every business failure carries systemic risk. The government can ensure a well-functioning financial industry, able to make new loans to creditworthy borrowers, without bailing out particular investors and institutions whose choices proved unwise." They also contend that "If the plan is enacted, its effects will be with us for a generation. For all their recent troubles, Americas dynamic and innovative private capital markets have brought the nation unparalleled prosperity. Fundamentally weakening those markets in order to calm short-run disruptions is desperately short-sighted." It sure looks to me like this large group of highly knowledgeable people don't believe that "the bill was better than nothing."

UPDATE #2: Co-blogger David Bernstein points out in an e-mail that the stock market often reacts favorably in the short term to any drastic action to control a perceived crisis. For instance, the Dow Jones saw a then-record one day increase when Richard Nixon imposed wage and price controls in August 1971. That euphoria faded as the true impact of this flawed policy became more clear over time. Today, few if any economists believe that Nixon's decision was a good one (many were highly critical at the time, too). Indeed, his policy is considered a grave error by most experts.

UPDATE #3: Jonah Gelbach at Prawfsblawg responds to this post, but mischaracterizes my argument. He claims that my position is based on the argument that "the stock market lost more in the crash of 1987" and "A recent petition signed by over 120 prominent economists from across the political spectrum" [expressing opposition to the bailout plan]. These points are not, of course, my main argument, which is that today's stock market crash does not prove that the bailout was a good idea because stock market conditions - especially short term swings - often don't reflect the underlying condition of the real economy. In this and the previous post, I give several reasons why that is true. The stock market crash of 1987 is just one historical example backing up the main point. Gelbach says nothing that disproves my more general arguments.

My citation of the the economists' petition merely serves the narrow purpose of rebutting Eric Posner's claim that "Nearly every knowledgeable person supported the bill -- in the sense of believing that the bill was better than nothing." Gelbach does make a worthwhile point in noting that the economists' petition has been revised to state that "This letter was sent to Congress on Wed Sept 24 2008 regarding the Treasury plan as outlined on that date. It does not reflect all signatories views on subsequent plans or modifications of the bill." Fair enough. But the amended plan does not change any of the features that the original petition objected to: that the bailout "is a subsidy to investors at taxpayers' expense" and that it "weakens" private capital markets through massive government intervention. The petition also objected to the original plan's seemingly excessive "ambiguity." But as Eric Posner points out, the amended plan actually gives the Secretary of the Treasury even broader discretion than the original one, thereby increasing ambiguity still further.

Thus, it is a reasonable bet that most if not all of the signatories oppose the amended bailout plan as well, or at least that enough of them do to undercut Eric's claim that "nearly every knowledgeable person" supports it as "better than nothing." Gelbach deserves credit for correcting the error about the petition. But the rest of his post isn't responsive to the real arguments that I raised in mine.

UPDATE #4: Gelbach has modified his post to emphasize that his point is that "serious people in the blogosphere are focusing on the wrong topic (the stock market)," which he believes is "remarkably wrongheaded." If a focus on the "stock market" is indeed "remarkably wrongheaded," it seems to me that any resulting blame attaches primarily to those raised the stock market decline as a defense of the bailout - not to those who sought to rebut that claim.