[lbo-talk] Wapo: Economists Question Basis of Paulson's Plan

Michael Pollak mpollak at panix.com
Fri Sep 26 22:08:05 PDT 2008


http://www.washingtonpost.com/wp-dyn/content/article/2008/09/25/AR2008092504531.html

By Neil Irwin and Cecilia Kang

Washington Post Staff Writers

Friday, September 26, 2008; A01

The Bush administration's pitch for a sweeping bailout of the financial

system has centered on two simple premises: that the economy could

suffer a crippling downturn if action is not taken very quickly and

that this action should consist of the government buying troubled

mortgage securities from banks and other institutions.

But many of the nation's top economists disagree with one or both of

those ideas, even as many top political leaders have swung behind them.

Wall Street economists have mostly endorsed Treasury Secretary Henry M.

Paulson Jr.'s plan, or a variation thereof.

But almost 200 academic economists -- who aren't paid by the

institutions that could directly benefit from the plan but who also may

not have recent practical experience in the markets -- have signed a

petition organized by a University of Chicago professor objecting to

the plan on the grounds that it could create perverse incentives, that

it is too vague and that its long-run effects are unclear. Sen. Richard

C. Shelby (Ala.), ranking Republican on the Budget Committee,

brandished that letter yesterday afternoon as he explained his

opposition to the bailout outside a bipartisan summit at the White

House. The petition did not advocate any specific plan, including that

offered yesterday by House Republicans.

Economists tend to agree that the nation's economy is at serious risk

as the flow of credit threatens to freeze. Just yesterday, the interest

rate at which banks lend to each other rose steeply, as it has every

day this week, suggesting that lenders are hoarding cash. History shows

that when this happens, a broad economic crisis can follow, for

instance, the Great Depression and Japan's decade-long recession in the

1990s.

"If nothing is done, the potential for these markets to seize up in a

big way is definitely there," said Frederic S. Mishkin, an economist at

Columbia University who was a Federal Reserve governor until last

month. "When you look at the history of these crises, when things spin

out of control, the cost to fix it later goes up exponentially."

But many others with a deep theoretical knowledge of finance and

experience in government are skeptical of the structure of Paulson's

plan -- and the speed with which it has been crafted.

The critics can be roughly divided into two camps. One group thinks

money should be directly infused into banks, which should allow it to

trickle down through the financial system to borrowers. A second group

thinks the government should buy individual mortgages, thus helping

ordinary Americans more directly, with the benefits trickling up to the

banks.

The plan promoted by Paulson and Fed Chairman Ben S. Bernanke is

somewhere in between: buying up packages of mortgages and hoping that

the benefits spread both up to banks and down to households.

"The plan is a trickle-down approach from banks to Main Street," said

Alan S. Blinder, a professor at Princeton University. "But if you

reduce the flood of foreclosures and defaults" -- which he would have

the government do by buying loans directly and then renegotiating the

terms -- "it will make mortgage-backed securities worth more."

That might help ordinary Americans but would be extremely difficult to

administer. The government would have to make decisions on the

foreclosure and resale of individual houses all over the country.

Still, many economists with left-of-center political views favor some

variation of this approach to the plan endorsed by Bush.

"There is a kind of suggestion in the Paulson proposal that if only we

provide enough money to financial markets, this problem will

disappear," said Joseph Stiglitz, a Nobel Prize-winning economist. "But

that does nothing to address the fundamental problem of bleeding

foreclosures and the holes in the balance sheets of banks."

Coming from the other direction, more conservative economists worry

that by having the government buy mortgage securities, the Paulson plan

would manipulate prices in that market without getting at the nub of

the problem: that banks do not have enough capital and are having

difficulty raising any on private markets.

In a sign of how the debate over the economy has shifted in recent

weeks, some conservatives, even as they argue for a relatively limited

government role, are calling on the government to invest public money

in private banks.

"The root of the issue is recapitalizing banks," said Glenn Hubbard,

dean of Columbia Business School and a former chairman of President

Bush's Council of Economic Advisers. "That could be done more

efficiently through the government injection of preferred equity. Then

the market could figure out the prices of the assets."

Many of these critics don't care for the assumption behind the

administration's plan that the market is now pricing these mortgage

securities incorrectly, a problem that the government intervention aims

to fix.

"The premise appears to be that the market is irrationally

pessimistic," wrote Greg Mankiw, a Harvard University economist and

another former Bush economic adviser, on his blog this week. "That

might be so. Nonetheless, one has to be at least a bit skeptical about

the idea that government policymakers gambling with other people's

money are better at judging the value of complex financial instruments

than are private investors gambling with their own."

Some conservatives are now arguing, notably, that the government should

be investing in banks.

Many economists fault the Bush administration and Congress for moving

so quickly on the bailout package without allowing more time for

debate. That sentiment was reflected in the petition organized by John

Cochrane of the University of Chicago. (None of the economists quoted

here were signatories.)

"I totally disagree that this needs to be done this week. It's more

important to get it right," Blinder said.

Moreover, some economists said the proposed $700 billion may not be

enough to address all the problems stretching across the financial

landscape. "You only show up if you can win, and this is not that

package," said Simon Johnson, a professor at Massachusetts Institute of

Technology and former chief economist at the International Monetary

Fund. "This cannot be the ultimate, decisive solution if you are not

addressing the underlying cause."

The plan is short on details, instead giving the Treasury secretary

wide latitude to determine how to execute the purchases of mortgage

securities.

"I'd like to see how they see the evolution of an end game. There are

still many questions," said Myron Scholes, a retired professor at

Stanford University and Nobel Prize winner. He said how long the

government holds the assets and how they are later resold would be the

keys to determining whether the plan works.

© 2008 The Washington Post Company



More information about the lbo-talk mailing list