On Mon, 29 Sep 2008, Gar Lipow wrote:
> Even in the short run there are more progressive ways to deal with this
> than just modifying Paulson's crap.
This is the key point: the short term: how short is it? Because if it's shorter than 4 months, the answer to this is no, we don't have time to do more than modify Paulson's crap. And if that's true, then the bailout the Dems came up with is actually surprisingly good -- it's the first time they showed leadership, intelligence and backbone since they were voted in 2 years ago.
> FDIC expansion
And this the key point about whether we have more time. It's Galbraith's first point, and it has become the foundation stone for others, like Dean Baker: that all we need to do in the short term is give $500 billion to the FDIC:
http://www.washingtonpost.com/wp-dyn/content/article/2008/09/24/AR2008092403033.html
With banks, runs occur only when depositors panic, because they fear
the loan book is bad. Deposit insurance takes care of that. So why not
eliminate the pointless $100,000 cap on federal deposit insurance and
go take inventory? If a bank is solvent, money market funds would flow
in, eliminating the need to insure those separately. If it isn't, the
FDIC has the bridge bank facility to take care of that.
Next, put half a trillion dollars into the Federal Deposit Insurance
Corp. fund -- a cosmetic gesture -- and as much money into that agency
and the FBI as is needed for examiners, auditors and investigators.
Keep $200 billion or more in reserve, so the Treasury can recapitalize
banks by buying preferred shares if necessary -- as Warren Buffett did
this week with Goldman Sachs. Review the situation in three months,
when Congress comes back. Hedge funds should be left on their own. You
can't save everyone, and those investors aren't poor.
With this solution, the systemic financial threat should go away.
<end quote>
Unfortunately this is wrong, because the first sentence is wrong. None of the banks runs we've experienced so far have anything to with deposit funding. They are a problem of investment funding. And that's not covered by the FDIC and can't be.
Galbraith himself recognized this when he says
<quote>
Keep $200 billion or more in reserve, so the Treasury can recapitalize
banks by buying preferred shares if necessary
<unquote>
What that means is: keep doing exactly what you're doing -- bail out banks and institutions or are suffering these other kind of runs (which is everyone so far) on a case by case basis just like we've been doing with everyone from AIG to Wachovia. Just sweeten the pot by getting stakes in the future in return for guarantees, as was done in the most recent case with Wachovia (where the FDIC got a $12M stake in preferred shares in return for guaranateeing to shoulder all losses over $42 billion. (Citi suffers all losses under that point on a loan book of $312.))
The problem is that this accelerated last week. That's the terror: it became perfectly plausible that virtually every bank could have a run. And then the system collapses. The only thing that damped this acceleration was the prospect of something more systematic, i.e., the bailout. And as soon as that prospect was withdrawn, panic resumed.
The point of the bailout is that financial institutions are now basically tornado country. Any butterfly wing can start a run, which is really nothing more than a self-confirming prophecy. Serial bailouts were not stopping this from getting worse, from us having more and more at one time, and thus accelerating toward the endpoint. So something else was needed to restore confidence -- something that would do for investment funding what FDIC insurance does for deposit funding: restore confidence so that people aren't afraid they'll lose their money -- to make the rumors that start runs ineffective.
This is why we need a bailout in the short term. That's why we can't wait 4 months. And I'm glad to see Galbraith has recognized this himself in the article posted today by Shane Taylor:
http://www.prospect.org/cs/articles?article=how_much_will_it_cost_and_will_it_come_soon_enough
Now Gar, I'm inclined to agree with you and most other progressive economists that a Swedish style bailout that injected preference shares would be a better bailout. But (a) that would cost much more than this -- people aren't really registering how much this is an attempt to do it on the cheap; and (b) it isn't being offered. In a crisis where you've only got a week or two -- and we are in such a situation -- you have to go with the Treasury secretary you've got and the Democrats you've got. Barney Frank and Chris Dodd are as far as the party is going to go right now -- there is nothing with their left to any power, and actually its kind of surprising and heartening that they finally have the power they have and that the Dems have deferred to them and grouped around their leadership.
The argument that we can do better than this *eventually* is absolutely true. And there is nothing stopping us in theory from doing much profounder things after the election. I'm all for putting out radical ideas. And I totally agree that the one wonderful thing about this crisis is that it suddenly makes tons of ideas thinkable that two weeks ago were considered beyond loony.
So by all means, talk about nationalizing finance and everything else. But talk about it in terms of what the Democrats ought to do in January if they win big. Talk about it in terms of a New New Deal. All of that will still be needed because we all agree the underlying problems are still there and still need to be addressed.
But to be at all credible, all of that has to be separated the idea of opposing this bailout. If you think you can use this failure to fundamentally change the bailout's shape, and replace the TARP program with a mass preference shares purchase, then IMHO you've entirely misread the politics that made it collapse -- it wasn't the votes of the left that brought it down. And if you think we can just stand pat and take care of everything in the spring, IMHO you're not understanding what happened last week.
Galbraith recognizes this. It's time for everyone who used him as a starting point to recognize it too. The question of a New New Deal and the question of WITBD this week are two different questions. Doing the bailout will not preclude doing a New New Deal next year. It will actually make it easier. The real barriers against are the barriers of American thought, and spending the next four month fighting against them would be a good fight. But opposing the immediate bailout doesn't help that effort. It completely discredits it.
Michael