Tuesday, September 23, 2008

Who's Right and What's Left?

One of the most interesting developments in the current financial crisis is the coalition of the left and right against the center (or what should probably be called the center-right, but I'll just call the center for simplicity.) Some on the right oppose the $700 billion bailout because it undermines market incentives. Thus, KY Rep Sen. Jim Bunning made this pitch: "It’s financial socialism, and it’s un-American." Meanwhile, on the left, there is marked skepticism for a plan that allocates billions to investors and nothing to people who have lost their homes, even as it radically undermines the possibility of other government programs, such as health care.

The media have tended to portray those who favor the bailout in its current form as a pragmatic departure for a generally conservative Bush Administration. But of course it is no such thing. Between the wars in Afghanistan and Iraq, the massive tax cuts, and the addition of the prescription drug benefit, the Bush Administration has been anything but fiscally conservative.

That said, the description of the bailout as "socialism" is somewhat off target. It might better be described as crony capitalism. The main problem with the proposed bailout is not that the government would end up running the economy; Sec. Paulson would almost certainly spin off or outsource the management of the junk assets the govt acquires. After its effect on all other government spending, the main problem is that the bailout would dramatically undermine the discipline of the market. Although it wouldn't make much difference in total cost to the taxpayers, I would include in any package a very high wealth tax on corporate CEOs, hedge fund managers, and others who who made tens of millions of dollars while creating a mess for shareholders. Such effectively retroactive taxation would satisfy the Constitution's minimal requirements for civil retroactivity. Of course, as some on the left argue (e.g., here), that still doesn't justify the bailout, but it would at least somewhat reduce the distorted incentives going forward.

Finally, the people, i.e., Paulson and to a lesser extent Bernanke, who are urging Congress to act quickly or risk meltdown are issuing a self-fulfilling prophesy. "The markets need to know we're fixing the problem right now, or we'll have an irreversible credit freeze and economic death spiral," they say. And then, surprise surprise, when Congress is slow to act, credit tightens and the Dow falls.

Posted by Mike Dorf

9 comments:

Craig J. Albert said...

I'll offer a modest proposal for more disclosure. It would be helpful to the public debate if we had a better idea of who is holding the securities that are at issue. The ownership of this wealth is largely anonymous, held in street names and trusts, and held by corporations whose shares are owned in street names and in trusts, so that we really have no idea of who is at risk of loss in the event of massive defaults. If the securities are held by US institutions for the benefit of US taxpayers and their retirement plans, then saving the holders from a huge market dislocation invokes one set of values. If the securities are held by, say, the Chinese government or by a family of sheikhs, then saving those holders from a market dislocation invokes a different set of values.

egarber said...

I understand that there comes a point when the aggregate economic impact of a failure requires action. This implosion will affect all of us, so I'm not opposed to federal action of some sort, although I'd rather see financial incentives to renogiate loans, as opposed to an RTC-style investment bank bailout. After all, economists basically agree that the root cause of this mess is plummeting home values. If you're gonna do anything, why not address the core problem? That way, you protect homeowners who were clearly victims of predatory lending, and you can claim to have "main street's" needs in mind.

If prices stabilize, all those securities will regain some or much of their value; if they don't, the taxpayers will be in a massive hole as we all sit on a pile of worthless paper.

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