Government Bailouts

[gc1765]

Bush proposes a government bailout of $700 billion dollars: link

What are your thoughts on spending hundreds of billions on such bailouts? What are the arguments for or against such a move?

Personally, I'm a bit skeptical because it seems to me that adding another $700 billion dollars of debt will not be good for the economy, but I'm the first to admit that I'm not an expert in economics...

[Riverwind]

What are your thoughts on spending hundreds of billions on such bailouts? What are the arguments for or against such a move?

It really depends on how the bailout is structured. If it is structured in a way that punishes investors and managers in irresponsible firms and protects creditors then it probably will be ok. If it is structured in a way that removes any incentive to avoid such messes in the future it will be a disaster.

[maldon_road]

The Bush administration asked Congress on Saturday for the power to buy $700-billion (U.S.) in toxic assets clogging the financial system and threatening the economy as negotiations began on the largest bailout since the Great Depression.

The rescue plan would give Washington broad authority to purchase bad mortgage-related assets from U.S. financial institutions for the next two years. It does not specify which institutions qualify or what, if anything, the government would get in return for the unprecedented infusion.

There's the rub. Will there be some cost to organizations having such assets taken off their hands?

No wonder McCain is nervous about it. If it's just the GOP rewarding their friends for incompetent management he could feel the effect on November 4th.

[August1991]

What are your thoughts on spending hundreds of billions on such bailouts? What are the arguments for or against such a move?

Personally, I'm a bit skeptical because it seems to me that adding another $700 billion dollars of debt will not be good for the economy, but I'm the first to admit that I'm not an expert in economics...

In principle, government bailouts are bad. They usually just encourage more of the same, bad behaviour. (This is true not only for wealthy bankers but also for junkees lining up at safe injection sites.)

Moreover, in the case of an insurance scheme such as Fannie Mae where the government in effect is fulfilling a promise to back a loan, the danger is that teh government provides the impression of security or the absence of risk. The State is a very seductive insurer because it can give the impression of security when in fact it is concentrating the risk in a single institution: itself.

----

With all of that said, Bush and Bernanke had little choice. $700 billion amounts to just over $2000 from each American. I'm sure each each American would gladly pay that to avoid the consequences of no bail out. America's money markets were on the verge of seizing up as American banks fell into a liquidity trap. The US economy is like a prefectly good engine about to seize up for lack of a quart of oil.

I don't know how situations like thgis can be avoided. Financial markets are prone to speculative bubbles and then panic sets in. In this latest example, it is the US real estate market that became a bubble and once the bubble burst, it lead to severe problems in certain financial markets. At least no one fears that US real estate will be valueless.

It really depends on how the bailout is structured. If it is structured in a way that punishes investors and managers in irresponsible firms and protects creditors then it probably will be ok. If it is structured in a way that removes any incentive to avoid such messes in the future it will be a disaster.

I agree.

Except for libertarians, most people believe that State-provided bank deposit insurance helps the banking system and makes the world a better place.

The problem is how such a scheme should assess premiums, pay out claims and police the conditions of its insurance policies. The modern State is a work in process. The US Fed only dates from 1913 and our Bank of Canada from 1935. (In some ways, I think teh Canadian method prior to 1935 is better. Then, a few large private banks (Molson, Bank of Montreal, Imperial) performed the tasks of a central bank.)

The economists and financial experts working at the Fed now are far better informed and have better data and tools at hand than Fed employees 50 years ago. Still, they are feeling their way in the dark and it's a steep learning curve.

Last point. I really don't like photo ops with Bernanke and Bush together. The Fed should guard as jealously its independence as the Supreme Court does. IMHO, the Americans should amend the US Constitution and give the US Fed equal status with the Executive, Congress and Supreme Court. The drafters of the Constitution, in the 18th century, had little knowledge of the role of a Central Bank (just as they had little knowledge of future weapon technology).

[August1991]

There's the rub. Will there be some cost to organizations having such assets taken off their hands?

No wonder McCain is nervous about it. If it's just the GOP rewarding their friends for incompetent management he could feel the effect on November 4th.

The figure of $700 billion is quoted above and even I referred to it as $2000/American.

That's wrong.

It is not clear at all how much this will cost the taxpayer. The Bush Administration wants to create an agency (a Quango in UK speak) that will buy up all these so-called sub-prime mortgages. What price will this agnecy pay? What are these mortgages worth? Ifthe agency sells these mortgages in the future, what will it receive?

No one knows.

I suspect that the $700 billion is an outside figure. At the moment, Bernanke and Bush are dealing with perceptions and signals. The oil that keeps the American economy is not money; it is trust. By announcing a large figure, the Administration is hoping that people's trust will return.

-----

If you are interested in this, here is a very good interview between Margaret Wente and Martin Feldstein, professor of economics at Harvard. Feldstein was an advisor to Bush Snr and is an advisor to McCain but I don't think he was involved with Bush Jnr. I'm surprised that Fee;dstein gave this interview.

Mortgage contracts are very different in the U.S. than they are in most other countries. As a general rule, they are so-called non-recourse loans, which means that if an individual stops making payments, the creditor can take the house - but if selling the house doesn't provide enough money to pay off the mortgage, the creditor cannot go after other assets or the income of that individual.

That's very different from Canada or virtually any other part of the world. It gives homeowners who have negative equity [i.e., mortgage debt bigger than the value of their house] an incentive to default because they'll lose less. They'll be able to walk away, rent and wait for prices to come down, and they will have escaped the full cost of the mortgage. Until that process stops, the crisis will not end.

G & M

I didn't know this. The US tax/legal system favours home buyers as opposed to renters.

Edited September 20, 2008 by August1991

[jdobbin]

With all of that said, Bush and Bernanke had little choice. $700 billion amounts to just over $2000 from each American. I'm sure each each American would gladly pay that to avoid the consequences of no bail out. America's money markets were on the verge of seizing up as American banks fell into a liquidity trap. The US economy is like a prefectly good engine about to seize up for lack of a quart of oil.

The historian Arthur Schlesinger used to say that liberal cycles succumb to the corruption of power whereas conservative cycles succumb to the corruption of money.

It is interesting that the Republican party has had to reject Friedman and depend on Keynes to bail them out.

[jdobbin]

I didn't know this. The US tax/legal system favours home buyers as opposed to renters.

The British too. They can write off the interest on mortgages as well.

Expensive policy and one that encouraged people to buy bigger houses over longer terms.

[August1991]

The historian Arthur Schlesinger used to say that liberal cycles succumb to the corruption of power whereas conservative cycles succumb to the corruption of money.

It is interesting that the Republican party has had to reject Friedman and depend on Keynes to bail them out.

It seems to me that Nixon succumbed to power whereas Carter succumbed to money - or at least the economy.

I agree however that this "financial crisis" is a classic Keynesian problem. The US Fed is now in the Keynesian macro world of perceptions and credible signals. As much as Leftists once exaggerated Keynes, the Right now too harshly denigrates him.

Greenspan, for all his Ayn Rand/Libertarian roots, had an appreciation and understanding of Keynes. (I say this having read Greenspan's autobiography and various interviews.) Friedman did too in his own way. Bernanke is a very smart guy but in terms of public message, the key job of the Fed, Bernanke is way out of his depth. This frightens me the most.

I blame Bernanke for this situation. He lacks Greenspan's or Volcker's weight. He's the Stephane Dion of the US Fed world.

Greenspan or Volcker or even Burns would have gone before Congress and put everyone at ease. This is a problem of perception, not substance.

Edited September 21, 2008 by August1991

[jdobbin]

It seems to me that Nixon succumbed to power whereas Carter succumbed to money - or at least the economy.

Nixon once said: "We are all Keynesians now" in response to LBJ cutting taxes in 1964. Nixon believed that he could steer the economy. Remember, he introduced price controls.

Carter also used Keynesian economics but he was the man who appointed Paul Volcker to the Fed to bring down inflation. He also reduced oil dependence down 50% as president.

The general malaise in the U.S. is not to be underestimated. The end of Nixon, the stagflation and energy crisis and the Iran hostages all contributed to a fall in confidence.

A lot of Jimmy Carter's problems were self inflicted but he appointed the right man to break the back of inflation and he shouldn't be forgotten for it. Regan can thank his lucky stars that Volcker was in place.

I agree however that this "financial crisis" is a classic Keynesian problem. The US Fed is now in the Keynesian macro world of perceptions and credible signals. As much as Leftists once exaggerated Keynes, the Right now too harshly denigrates him.

Why can't people settle on something in between? It would certainly help when solutions are needed.

I blame Bernanke for this situation. He lacks Greenspan's or Volcker's weight. He's the Stephane Dion of the US Fed world.

Baloney on that one. Bernanke is still dealing with some of Greenspan's hands off approach as well as a deregulation hands off approach that was practiced in government.

Greenspan or Volcker or even Burns would have gone before Congress and put everyone at ease. This is a problem of perception, not substance.

Greenspan would not done much differently than what we have seen now.

[gc1765]

Apparently the stock market lost $1.2 trillion today alone, which is more than the $700 billion bailout would have cost. In hindsight, I guess the bailout would have been a good thing.