The Argument Against The Bailout
By Doug Mataconis | Related entries in General PoliticsSince Justin has made a fairly strong and persuasive argument in favor of the bailout bill currently being debated by the house, I offer in response a morning post from my personal blog setting forth the arguments against…..
While it seems likely that the Democratic and Republican Congressional leadership will be successful in hammering the Paulson-Bernake bailout bill through Congress this week, there are some people out there making the case against the biggest government intervention in the financial system since World War II.
Casey Mulligan, an economist at the University of Chicago, for example, shows us that, while Wall Street is hurting from the mistakes that have been made over the past decade or more, Main Street is still doing relatively well:
Since World War II, the marginal product of capital after-tax averaged between 7 and 8 percent per year. During 2007 and the first half of 2008 – exactly the time when financial markets had been spooked by oil price spikes and housing price crashes – the marginal product had been over 10 percent per year: far above the historical average. Compare this to the marginal product of capital in 1930-33 (the years of Depression-era bank panics): 0.5 percentage points per year less than the postwar years and significantly less than in 1929. The marginal product of capital was also below average prior to the 1982 recession (in this case, far below average) and prior to the 2001 recession. Thus, the surprise was not that GDP continued to grow 2007-8 despite the bleak outlook from Wall Street’s corner of the world, but that GDP growth failed to be significantly above the average. More important from today’s perspective is that much capital in America continues to be productive, and that this will likely permit Americans to advance their living standards as they have in years past. The non-financial sector today looks nothing like it did in 1930.
The weak correlation between asset prices and non-financial sector performance and the strong profitability of today’s non-financial capital are two good reasons to scoff at the idea that the non-financial sector will collapse because of the recent events on Wall Street, and even better reasons to scoff at the Bernanke-Paulson-Bush idea that a massive bailout of financial firms is the key to avoiding a non-financial collapse.
Following on Mulligan’s point, Dale Franks reminds us that the Fed will have to “create” the $ 700 billion that will fund this plan out of whole cloth, which will have implications of it’s own:
[W]hatever money the Treasury pours into the MBS market is brand spanking new money. It’s no different than if the Fed pumped $700 bil in cash into the economy buy buying 1-year noted from every Federal bank in the country. Such a massive increase in the money supply is wildly inflationary.
That give rise to two problems.
First, we’re intentionally inflating the money supply, which will further crush the dollar in the FOREX markets. It will expose foreign holders of government and commercial paper to increased exchange rate (currency) risk that may very well force them to sell off that paper. If they do, he glut of bond sale will cause bond prices to fall, and yields, i.e., interest rates to rise sharply. It won’t matter if the Fed lowers the Discount Rate to 0% and opens the Fed Funds window as wide as it can go. Sales of commercial and government paper can force interest rates through the roof. The high price of money will stifle credit demand all across the economy, slowing GDP growth substantially.
(…)
Second, even if the above wasn’t true, the increase in inflation would inevitably require the Fed to ratchet up interest rates in order to get inflation back under Control. We’d be right back in 1981-82 territory again, which, for those of you who don’t remember, meant 18% mortgage rates, and 11% unemployment.
Franks goes on to note that the bailout doesn’t avoid the pain of more than a decade of bad decisions, but merely transfers it from those responsible for the problem to the public as a whole:
The only question now is who feels the pain. And, as my previous point indicates, the Government is on the verge of spreading that pain around, and we may all feel it sharply.
(…)
[S]omeone is going to feel the pain. The only question is who feels it. Right now, it looks like the answer to who feels the pain is, thanks to the government, “All of us.”
And, then, as I noted yesterday, there’s the immense moral hazard problem that this bailout creates.
If homeowners, bankers, mortgage lenders, mortgage brokers, securities traders, and politicians can spend a decade or more making bad financial decisions only to have the government step in at the last minute and save them from the consequences of their actions, then what signal does that send to the next person inclined to take an insane risk ?
Part of capitalism includes the risk of failure, and when people make financial decisions they ought to calculate those risks into their decision making process. When the government stands on the sideline and says that they’ll save you if you fail, it makes it a lot easier to take risks that harm not only yourself, but others as well.
Whatever that is, it’s not capitalism, but it’s what we’ll be left with after this bailout becomes law.
This entry was posted on Monday, September 29th, 2008 and is filed under General Politics. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.
September 29th, 2008 at 10:41 am
Listen Doug, those are all fair points but NONE of them actually addresses the reality of what could happen if we do nothing.
First off, the Chicago economist you cite is incredibly short sighted because all he does is hope that other institutions will step in…
I’m sorry Doug, but the market isn’t quickly reacting to anything right now and for Casey to be so nonchalant about this reveals a certain academic blindness to the realities of the crisis we’re facing.
Also, he talks as if the collapse of the financial sector would only hurt jobs within the financial sector…not giving any credence to the dangers a massive credit crunch would create for the non-financial sector.
In other words, his numbers may be correct, but they don’t matter because his premise is WAY off.
Also, to this point…
Well sure, we all know how capitalism ought to work, but in this case we have a very special situation where a MASSIVE bubble has burst and the mechanisms of the free market have ground to a halt.
In short, this isn’t just about banks losing money…it’s about ALL of us losing money and, most importantly, jobs. Not being able to get loans will absolutely cripple our economy. That’s the moral hazard I’m worried about, not whether or not we stick steadfast to the “pure” tenets of capitalism.
Last…I understand that this will hurt the dollar. But I’d rather hurt the dollar at this point then risking losing millions of jobs.
In any event, good post and I appreciate the fact that you shared it…even though I agree with none of it. :-)
September 29th, 2008 at 10:52 am
Justin,
Several points.
First of all, not everyone agrees with the Bush Administration that failure to pass this bailout bill at this time will lead to disaster. There are plenty of economists I could name in addition to Casey Mulligan who have questioned the veracity of statements of impending doom by the likes of Paulson, Bernake, and Bush. As for Jim Cramer……well, I learned a long time ago not to take advice from hot heads and Cramer is a hot head. Back in March he was telling his viewers that Countrywide was a safe investment despite signals of impending doom. A week later, the company cratered and the stock was worthless.
Second, as Dale Franks points out in the second post I linked to, the only thing that this bailout is accomplishing is delaying a seemingly inevitable day of reckoning. We’ve been butting off the consequences of easy credit, a dollar with fictional value, and out of control government spending for decades now — this bill may buy us some more time, but it doesn’t mean the bill won’t come due. Why wait ?
Third, you concede that this bailout will hurt the dollar. Heck, if some of the stuff I’ve been reading this morning is right, it could end up crippling it to the point where the world finally looks to the Euro as it’s store of value. Even if that doesn’t happen, though, another dollar collapse will hurt the economy immensely.
Finally, this isn’t about protecting “pure” capitalism, it’s about facing up to reality which is the one thing this bailout bill is shielding everyone from.
September 29th, 2008 at 11:18 am
The University of Chicago School of Economics should be renamed the First Church of Free Market Inerrant. They’ve become a group of hide bound predictable ideologues. And after reading Franks’ article he seems to be a member of the Church. Your last paragraph seems to conflict with your sources.
September 29th, 2008 at 11:24 am
Selected quotes from Franks:
“The market actually works.”
“But let’s be clear about one thing: The root cause of all this is that the Federal Government urged—and then mandated—that bank loan portfolios included an increasing number of loans to politically favored groups, more or less irrespective of the loan recipient’s creditworthiness or ability to pay.”
I add the emphasis because I have yet to see one of the ideologues making this claim back up that part of it.
“Ownership warrants are death to capitalism
No way. No how. Once you open the door to government ownership of private firms, you can toss the free market right out the window.”
It’s not about the ideology, Doug? Tell us another one.
September 30th, 2008 at 1:37 pm
Why should anyone be burdened with bailing out someone who took a fixed rate mortgage on a home expecting the bubble never to burst? Why should anyone be burdened with bailing someone who trades on Wall Street? It’s like no one accepts the worst case scenario is possible when it comes to their money. Is it reasonable for me to ask tax payers to back me at the roulette table in Vegas? That’s not a knee-jerk, that’s exactly what this is. People gambled, lost, and now are crying.
People deserve to be parted with their money and homes for taking that risk and losing. Banks deserve to fail and close for giving those loans in the first place.
A middle-class American who owns no stock and no homes has nothing to do with this situation.
Even if it DOES end up hurting the nation as a whole, those people who took those irresponsible risks are to blame and should be burdened, not those who were fiscally responsible.
The lack of personal liability when it comes to money is at an all time low, many of this nations problems could be solved if people would own up and pay for their OWN mistakes.
October 1st, 2008 at 2:56 pm
Justin -
Can I borrow some money? Oh, and if I can’t pay you back just take it from someone else who doesn’t owe you!
October 2nd, 2008 at 8:19 pm
I’ve been thinking about this a lot (as we all have) and it just occurred to me tonight… I’m be more than happy to agree with the “rescue” plan if Congress will do two things…
1. Hold themselves accountable (by name… not House or Senate but by individual names) if this thing doesn’t work. I want to know who screwed up!
2. Agree to some punishment if their plan doesn’t do what they are promising it will do. Punishment and an agreement that they will resign their post… Immediately!
I want to see some accountability before I will agree to this approach.