Do read up on Arnold Kling before proceeding. From my outsider’s vantage point, it seems that commercial bank failures and consolidations are already being handled (see Alex’s recent posts) and of course the investment banks are gone. Money market funds are now (mostly) insured. I see three key questions for the next few weeks:
1. Will there be a run on hedge funds?
2. Will the commercial paper market dry up?
3. Will the Fed have to bail out any major foreign banks?
At this point, perhaps the Paulson plan is directed against these contingencies rather than being for the commercial banking sector per se. From this list, it is least clear how the Paulson plan would handle #2, although you could point to a short-run confidence effect. Will that last? #2 is the hardest to handle without implicitly socializing parts of the real economy and if you have good proposals for #2 please let us know. How much can corporations bypass the commercial paper market altogether?
"Recapitalization is a public good" is one key phrase for this crisis; "no natural buyers" is another. So far debate over the plan has focused on the first phrase but not the second.
Addendum: Bruce Bartlett defends the Paulson plan. So does Kudlow.
Here’s my proposal. Let me buy my own mortgage back for 22 cents on the dollar.
One of the things that has pushed (and been successful) home ownership has been the mortgage interest deduction. I’m wondering if something similar could be done for a 1-2 year period for short-term commercial paper. In other words, could a corporate tax write-off of the interest of short-term loans be put in place for a couple of years?
Commercial paper is an important market, but all or virtually all non-financial company issuers have back-up lines of credit with a bank to protect them from temporary disruption of the market. This is a lesson learned from the Penn Central crisis.
Can commercial banks provide credit to all the commercial paper issuers? Access to money is no problem. The banks can borrow from the Fed’s discount window, and the Fed would be happy to lend to banks for this purpose.
The challenge might be that additional bank lending would balloon bank balance sheets, which would require additional capital. However, non-financial company commercial paper outstandings run about $200 billion, while total banking industry assets are $11 trillion. So no problem.
The real decline recently in commercial paper oustandings is from financial company issuers. These outfits can access Federal Reserve borrowing directly now.
So the bailout bill is not necessary because of the commercial paper market.
Drop FAS 157 and adopt innternational accounting standards. THe problem vanishes.
It’s worth considering the position on this of BB&T bank:
http://media.gatewaync.com/wsj/pdfs/2008/09/allison.pdf.
See CEO/Chairman John Allison’s letter to Congress. I think this bailout is less necessary than suggested by some in DC and on Wall STreet.
First, this is not 1930. We will not see another great depression, no matter how hard the government tries. Otherwise, Bartlett is pretty good.
Bartlett: “The basic problem is that the financial sector faces systemic risk in a way that no other industry does: By its nature, it is a house of cards that can collapse at a moment’s notice.”
“The second problem with the financial system – again, by its nature – is that banks borrow short and lend long.”
Now, those are damning admissions for a mainstream economist in the guise of support. Are we sure the by-line didn’t get swapped with the letter from Ron Paul? Someone has been readling Austrian books in their time off. I think the next administration could probably fill all slots with individuals stabbed in the back by this one.
All we really want is to maintain the institutions to the extent that they make the market. All the failures need to go out of business eventually, and bad bets must be sold off.
Ideas (mostly not original):
Suspend mark-to-market accounting rules until they can be rationalized. Imagine if value investors (i.e. the only real investors) had to live by mark-to-market.
Whatever the Fed is doing behind the scenes to push the rapid de-leveraging, stop.
Cut taxes on CDs and anything that provides long-term capital by contract.
Stop auctioning treasuries shorter than 3 years.
Cut all taxes, most regulation and whatever else on home-based businesses.
Fast-track worker visas for educated immigrants that have employer sponsors.
Replace all incumbents and incumbent parties if possible.
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