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Finance Q&A

Will Slack ’11 has questions about the bailout. Below, I provide answers.

After having read several articles on the bailout ranging from never to now, it occurred to me that I should really get back to my third ECON 110 problem set and let the people who know what they’re talking about provide the commentary, without trying to play political games.

So was it a good idea?

Most experts think that this bailout was poorly designed. There are good ways to do a bailout and bad ways. The bill that was voted down in the house was one of the bad ways. See here for more.

Do we need this NOW?

That’s the rub. Although professionals almost all agree that this was a bad bill, many argued that a bad bill today is better than a better bill three months from now. See Krugman. But there was an active debate in the professional community about this claim. The central debate was, obviously, what would the world look like without a Yes vote on this bill, and how does that compare with a world without the bill? Counterfactuals are tough, but it sure looks like we are getting a view of how the world looks without the bill.

What’s going on?

The central reality is that the US economy is in a recession. Unemployment is rising. Production is falling. And so on. The unknown is how bad this recession will get. No one knows.

Paulson and others pushing for THIS BILL NOW argue that the financial markets are under such extreme stress that a bailout must happen right now, otherwise UTTER DISASTER. The problems with this argument are:

a) Lots of people think that Paulson and his Wall Street buddies are “talking their book,” i.e., arguing for actions that benefit them monetarily. For example, if the US Government buys lots of dreck from Goldman Sachs, then the owners of Goldman Sachs (including Warren Buffet) are better off. Are the rest of us? Maybe, maybe not.

b) Lots of people think that Paulson et al are crying wolf. Didn’t Paulson argue that we needed immediate action 10 days ago? Has the world ended? Not that I can tell. If the world doesn’t end in the next week or so, why should anyone believe Paulson (or Bush or Dodd or Frank or ….).

c) Lots of people think that the markets are due for a correction no matter what the government does. We have just had the largest credit bubble in 50+ years. No force on Earth could prevent home prices from falling, the stock market from going down. Indeed, I (and others) think that Greenspan and others created the credit bubble by constantly adding liquidity to the system for the last decade or more. It looks like that trick won’t keep working.

d) If you really believe that the world will end without this bill, then you ought to be able to point to better evidence of trouble today. (And, No, a 8% fall in the S&P does not count.) Paulson et al claim that credit markets are seizing up, but this does not seem to be true.

Just because IBM needs to pay 5% instead of 2% to borrow money for 30 days does not mean that the system has failed. Maybe IBM ought to pay 5%. Just because you need to put down 20% to get a mortgage does not mean that the world is ending,. Maybe you ought to have to put down 20%. (Letting people only put down 5% is, obviously, a bad idea.)

e) The public hates the bill, just despises the whole idea of spending $700 billion to bailout Wall Street. I saw this ad on CNN on Sunday.

Harsh. But the exact same ad could be made about almost any incumbent, Democrat or Republican. (Even the most honest politicians have received money from Fannie/Freddie/Wall Street.) The reason that the House leadership (both Democrat and Republican) had so much trouble gathering votes is partially because some members did not like the bill. But all members recognized that the politics or it were horrible. (I expect that Chris Murphy’s ’96 opponent will try to use his Yes vote against him.)

If the credit market truly seizes up in the next few days or the stock market drops 20%, then I could imagine a bill getting done. But if things just sort of drift tomorrow and Wednesday, it is hard to see where the enthusiasm for the bill will come from.

Other questions?