What should we now think about the bailout?

by on November 14, 2008 at 6:33 am in Economics | Permalink

One very loyal, and libertarian, MR reader writes to me:

But I was actually somewhat (not altogether) surprised by your support for the bailout package.  So let me ask you again, what would cause you to disagree with yourself?  I guess I’m asking because I can’t provide good answers to the following questions: What information do policymakers have to get it right? And what incentive do they have to get it right? Therefore, I don’t see how they will get it right, and are more likely to do long and short run harm.

In my view the real bailout is the existence of the FDIC which, like it or not, is not a commitment we cannot walk away from.  Had nothing been done, the required FDIC bailout of bank depositors would have been enormous, given frozen interbank credit markets plus a certain level of panic.  So in reality I favored a smaller bailout than did most of the "purer" libertarians, although MR commentators rarely frame it as such.   

A combination of bank recapitalization (which I was first skeptical about and thus have changed my mind on) and a greater emphasis on an "identify and isolate the bad banks" approach was the right bailout to do, not to allocate $700 billion for TARP.  I agree with everything Arnold writes in this post, but still in my view "doing nothing" wasn’t really an option, again if only because of the preexisting FDIC commitment, not to mention the disaster associated with a plummeting money supply. 

Now that financial confidence is partially restored, we can hope that the Obama administration redoes the deal.  But the money is being committed rapidly and the demands of the interest groups are piling up, so I hardly expect much ex post improvement.

As for changing one’s mind, it is hard to get real evidence on this since we won’t be running the counterfactual of no bailout.  If I learned that interbank exposure and counterparty credit risk was much less than I had thought, and that the number of potentially insolvent banks was quite small, then yes I would change my mind and favor no bailout at all.  But I haven’t learned that.

josh November 14, 2008 at 7:41 am

So how much of this money is actually going to end up going somewhere useful toward making sure we don’t end up in a long recession? 50%? 10%? 0%?

TA November 14, 2008 at 8:38 am

I don’t know whether I get what you are saying here. I take it you believe that, without the bailout, we would have had, or would be about to have, a lot of commercial bank failures — thus the point about FDIC exposure. These would be failures due to insolvency, not bank runs, right?

So what’s the exposure that causes so much insolvency? Since commercial banks are supposedly not direct holders of the kind of subprime mortgages that went into private securitization, it would have to be holding of the ABS securities themselves, maybe alt-A mortgages,which haven’t been so much a part of the discussion, maybe a lot of prime mortgages that aren’t so hot either. But how much could these losses be? And what difference does interbank lending make to all of this?

Also, I don’t see the reaction to the $250 billion (less $25 that went to investment banks) as that of desperate men saved from ruin. They’ll take the money, sure, and may need it in some cases, but it seems like a whole lot less might have sufficed. But maybe that’s your point.

jason voorhees November 14, 2008 at 9:08 am

These would be failures due to insolvency, not bank runs, right?

TA – wouldn’t they be both? It seems like both is going on. Insolvency is the main problem triggering aggregate demand shocks like reduced spending, reduced investment, and bankruns. That’s also what makes the fiscal stimulus discussions a little weird. IF the main problem is insolvency, then what can fiscal or even monetary stimulus really do?

Bob Murphy November 14, 2008 at 9:57 am

In my view the real bailout is the existence of the FDIC which, like it or not, is not a commitment we cannot walk away from.

I agree, though only because (I think) you unintentionally used a double negative.

So in reality I favored a smaller bailout than did most of the “purer” libertarians…

No you didn’t Tyler. There’s a lot you can say, but don’t pull that line. That’s like the warhawks who say we should strike Iran now to prevent a bloodier “necessary” war down the road. Yeah, if you get to dictate what all the “realistic” options are, you can always paint yourself as the moderate and sensible one, even if your predictions turn out to be totally wrong and the people saying “Don’t do it! This is nuts!” are totally right.

Even on your own terms, your defense only makes sense if you think the $700 billion bailout was a sort of pre-emptive move that would have changed the market values even on the assets remaining untouched by the bailout. (Without such a story, then you can’t say it saved us money that we would have ended up spending through FDIC.) So do you really think all of this garbage in the past few months has restored confidence in investors? Paulson asking for the TARP, then spending it all on bank recapitalization, and now (according to this ABC story) even admitting that he knew the TARP wouldn’t work when the bill was signed? And you still have no regrets in any of this?

If I learned that interbank exposure and counterparty credit risk was much less than I had thought, and that the number of potentially insolvent banks was quite small, then yes I would change my mind and favor no bailout at all.

Not only does Tyler think Alex is nuts on the “credit crunch,” he’s willing to bet $700 billion on it! :)

Bob Murphy November 14, 2008 at 10:02 am

Third time’s a charm: Here it is (I hope)…

Tim November 14, 2008 at 10:17 am

I actually read that as of a few days ago only 60 billion of TARP had not been committed (probably less now).

RS November 14, 2008 at 10:55 am

“If I learned that interbank exposure and counterparty credit risk was much less than I had thought, and that the number of potentially insolvent banks was quite small, then yes I would change my mind and favor no bailout at all..” I had lunch yesterday with an insider on the numbers at a major money center bank.. evidently, the risk wasn’t much less than you thought, rather, much more than the insiders ever imagined. More troubling is that the insiders apparently don’t actually know from week to week what the risks are. Ergo, the feds don’t know either. However, the known risks apparently rise every time they are estimated…

joe November 14, 2008 at 11:28 am

Just to be clear, the GSEs are losing money, but the $25B+ losses they have reported this week are an accounting loss based on the write down of their massive deferred tax assets. You can argue that this implies there won’t be any profits in the future, since that’s why you write down a tax asset, but it’s not an actual cash loss today.

Massimo GIANNINI November 14, 2008 at 5:17 pm

What should we now think about 700 billion bailout? Nothing, anymore, as Krugman is suggesting adding another 600 billion fiscal stimulus here http://www.nytimes.com/2008/11/14/opinion/14krugman.html and here http://krugman.blogs.nytimes.com/2008/11/10/stimulus-math-wonkish/.

Is all this “Moving forward with deliberate haste” or throwing number and money?
http://mgiannini.blogspot.com/2008/11/throwing-numbers.html

meter November 14, 2008 at 5:34 pm

That’s about the only correct thing Paulson has said in months. Better late than never.

J Thomas November 14, 2008 at 8:49 pm

When BOTH SIDES of the aisle were pushing this in a big HURRY, just like they rammed
through Sarbanes Oxley-we were told it would avert a cataclysm. Now we’re told by the time
the hammered it through, it was the wrong move.

The OODA concept needs wider use.

Small-unit commanders got taught to do something, anything, rather than sit tight. Even doing the wrong thing is better than doing nothing. There’s a reason for that. When they do nothing the enemy can find out where they are and do whatever seems best about that. Do something to mix things up and they might find out something themselves while the enemy’s information lags behind. Even if the small unit heads into disaster that will tell higher command something worth knowing.

But when Congress tries to do something random faster than they can think about it, they are extremely unlikely to get a good result. Better for Congress to do nothing than to panic.

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