Nationalization of US Credit Markets: Where Is the Analysis?

29 September 2008 at 11:11 am 4 comments

| Peter Klein |

Over and over during the last week we’ve been told that unless Congress, the Treasury, and the Fed take “bold action,” credit markets will freeze, equity values will plummet, small businesses and homeowners will be wiped out, and, ultimately, the entire economy will crash. Such pronouncements are issued boldly, with a sort of Gnostic certainty, a little sadness for dramatic effect, and only minor caveats and qualifications.

And yet, details are never provided. The analysis is conducted entirely at a superficial, almost literary, level. “If the government doesn’t act then banks will be afraid to lend, and people can’t get credit to buy a house or expand their business, and the economy will tank.” Unless we rescue these particular financial institution, in other words, a massive contagion effect will swamp the entire economy. But how do we know this? We don’t. First, we don’t even know if there is a “credit crunch.” Nobody has bothered to provide any empirical evidence. Second, even if credit markets are tight, does it matter? Any predictions about the long-term effects are, of course, purely speculative. Sure, borrowers like cheap and easy credit and tighter credit markets will leave some borrowers worse off. But what are the magnitudes? What are the likely effects on the economy as a whole? (Possibly zero.) What are the possible scenarios, what is the likelihood of each, and how large are the expected effects? Where is the cost-benefit analysis? After all, the seizure of Fannie and Freddie, the takeovers of AIG and WaMu, the modified Paulson plan — the effective nationalization of the US financial sector, in other words — ain’t exactly costless. There are direct costs, of course, to be borne by taxpayers, but the possible long-term effects brought about by increased moral hazard, regime and policy uncertainty, and the like are enormous. Even on purely utilitarian grounds, the arguments offered so far are tissue-paper thin. 

Perhaps the dopiest remark I heard today was from Jamie Galbraith on the Diane Rehm show. “I’m a risk-averse person, and the risk of doing nothing is too great.” Huh? Um, shouldn’t a risk-averse person compare the risk of doing nothing with, well, the risk of doing something? Jamie, are the provisions of the bill making its way through Congress this morning risk free?

Entry filed under: - Klein -, Public Policy / Political Economy. Tags: , .

Government Funding and the Economic Organization of Scienctific Research A Critique of Modern Law and Economics Research

4 Comments Add your own

  • 1. TRUTH ON THE MARKET » Questions on the Bailout  |  29 September 2008 at 12:33 pm

    [...] Peter Klein: Over and over during the last week we’ve been told that unless Congress, the Treasury, and the [...]

  • 2. sr&ed  |  29 September 2008 at 12:35 pm

    What’s wrong with letting some more of these businesses fail? Bailouts will make companies less competitive in the long run. Shouldn’t businesses that make bad business suffer the repercussions of their decisions?

  • 3. spostrel  |  29 September 2008 at 6:48 pm

    I agree that the analysis is thin. What seems to be driving the policymakers at Fed and Treasury is a set of unprecedented market events such as a collapse of interbank lending. It is not clear that these events are the harbingers of immediate Depression, however, nor is it clear that the proposed intervention will even have the desired positive effects in return for the negatives mentioned in Peter’s post.

    If we are going to have a government-as-hedge-fund intervention aimed at preventing temporary liquidity problems from causing contagious credit collapses, I would prefer to temporarily (say for six months) offer a guarantee of high-quality borrowers, especially industrial AAA commercial paper (possibly in return for a fee of a few basis points). In all lilelihood, this will cost the taxpayers nothing and it will let all the solvent firms meet their payrolls.

    With this approach we aren’t “bailing out” anybody, just preventing the contagion until we can sort out the MBS, CDO, and CDS markets with tough restructurings. Those restructurings will essentially have to convert debt contracts to equity contracts, under some guise. Much of this restructuring might go forward with minimal government involvement.

  • 4. Praja Rajyam  |  1 October 2008 at 3:19 am

    What we are foreseeing is a mixed-economy where regulators will be crucial. If we have more ‘failures’ there will be more burden on the tax payer (on account of bail outs) – but, when there is a success, they don’t share the profits with the tax-payer. Don’t you think this is unfair?

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