First, a disclaimer: all the formal schoolin’ I’ve had in economics came in one semester of macro with the excellent Dr. Werner Sublette, who had a reputation for being a very difficult professor. He was one of my favorite teachers as an undergrad—the material was fairly difficult and he demanded you learn it well, which takes hard work. He didn’t assign busy-work or anything like that to make the class more difficult than it needed to be, but if you passed his class, you’d know the stuff well enough that you wouldn’t embarrass him in your future work (as I may do in the coming paragraphs). I haven’t even gotten around to reading Thomas Sowell’s Pop-Econ book, which I’ve heard is excellent and is in the queue.
All that said, I’ll go ahead and stick my thumb in the door hinge by giving an opinion on the “bailout” plan… (Some of this copy-and-pasted from my side of an email exchange earlier.) I’ve read quite a bit over the past week with my BS-detector set to DC and think I’ve got the idea. I’ve also talked to enough people to know that the severity of the crisis is lost on the majority of those in the circles I run. This column from today summarizes things pretty well, I think.
I think it’s essential to pass the bill quickly with minimal changes. The bill gives the Department of the Treasury authority to buy up to $700 billion dollars worth of mortgage-related assets from companies headquartered in the US. They’re required to report to congress three months after the law passes and every six months afterwards.
These are the “minimal changes” I’d like to see:
- I’d definitely want to see a deadline for this subentity in Treasury, public corporation, or however it’s structured to finish buying up bad paper: the three months between the day the program gets off the ground until their first appearance before congress would be perfect.
Make the banks decide quickly what they want to unload, make them unload it to get things moving fast, and make sure the monster doesn’t stick around forever. Three months of buying followed by a few years of restructuring the debts, followed by securitization and a sell-off period until the debt’s all gone: sold or defaulted. If Treasury needs more time to buy, they’d need congressional approval for an extension when they first report of either three or six months to the next report.
- Congress wants oversight of Treasury’s moves, which I think would be a very, very bad idea; but I’d like to see the thing made more transparent. They should mandate a publicly accessible database to show how much paper was bought from whom and at what price, but treasury should be free and flexible to make those buys without waiting for congressional approval. (Transparency good; oversight bad.)
- I’d like to see the price on the toxic debt set very low, some sort of market mechanism to be used to set the price—a plan floated for a reverse auction sounds reasonable, although has apparently been rejected already. The paper these banks need to unload would be ones worth nothing or next to nothing on the market today, so 25 cents on the dollar seems like more than a sufficient offering price to open up these firms’ balance sheets and get reliable credit flowing again. There should be some mandated cap on the price Treasury is authorized to pay, no higher than 50 cents on the dollar. Treasury shouldn’t be competing with other banks that’d want to buy these securities and other assets; and certainly should avoid deflating the market for any but the most toxic mortgage-related assets. The worthy goal, as I understand it: we’re not trying to bail out banks by infusing them with cash, we’re trying to stabilize their balance sheets by taking crappy loans off their hands. I’m not interested in punitive measures or anything, but the buying price for this sludge needs to be low enough that it’ll be a painful decision for firms to dump it and that the gov’t has a chance to not see ALL the paper default. Some of these companies will still fail–if they do, they were managed poorly enough that they should fail, but we can’t have it that almost all of them are failing.
If they set that buy price right, this thing’ll work and they won’t need to spend the $700-trillion figure that Treasury’s asking for. If they set it too high: they’ll spend too much, never make it back for the taxpayers, and set a piss poor precedent in moral hazard terms. If they set it too low, they won’t drain enough crap out of the system to get things working again. I’d frankly prefer they err on the side of miserliness in this case. Some firms need to fail. Some people may need to go to prison.
- I’m also not keen on Pelosi’s wish for taxpayer cash to directly bailout homeowners in mortgages they can’t afford. It’d make sense to give treasury wide latitude to restructure mortgages close to foreclosure in some way to get these homeowners on escalating payment plans to get some of the debt paid down. In other words, once Treasury owns some package of mortgages, they should de-securitize it, separate the wheat from the chaff, and rework the mortgage terms on the very bad loans to avoid foreclosure to the un-credit-worthy homeowners in creative ways. For example, refinancing a mortgage in foreclosure into a 30 or 40 year amortized mortgage where the monthly payment is initially set low and increases proportional with projected GDP growth, correcting along the way along with a low-cost program to strongly encourage these homeowners to pay extra principle down each month to incrementally pay the mortgage off the back-end. Ideally, you put together the right kind of programs like those and the loans rebuild value over a few years during which the Treasury could eat the short-term losses that a private bank may not have been able to ride out. If some of the homeowners can make their payments responsibly and keep up with the growth of the economy in terms of their own buying power, those mortgages would be greatly strengthened in value.
[Added later: I've read quite a few arguments from real economists for why the plan is terrible (notably this one. They all seem to assume that Treasury will be buying these assets at "inflated" or "premium" prices and my reading of the tea leaves suggests that's a mistaken assumption. I don't see this as a Treasury plan to directly capitalize these firms in exchange for worthless paper, but a plan to reduce firms' unmovable liabilities to let them get back to business a little wiser in the way described here. If that's what Paulson wants to do (pay market rates from two years ago for today's garbage), then yes, it would be stupid; and yes, I think his mandate should be clear that that is not how he may spend the taxpayers' money.]
I’m most nervous about who’s going to be running this thing next year and beyond. Don’t want it turned into anything it’s not meant to be; and the people running it are going to have to be some smart, creative people. Done right, this will be a gain for the taxpayer over the span of several years, even leaving aside the crippling damage that would be done by continuing to ignore the problem.
A few other comments, only peripherally related to the Big Deal: inflation rates need to be raised at some point soon. Treasury buying up these assets, even at discounted prices, are going to have an inflationary effect; the dollar’s weak; and we’re a spaz-out from an Ahmadinijad or a Chavez away from severe, continued energy-related inflation. I’m not advocating the sort of tight monetary policy that made the Great Depression so severe, but interest rates can’t be set lower than the rate of inflation for much longer. To counteract the anti-growth effect that’d have, I’d be tickled pink to see a corporate tax cut like McCain’s advocating. He’s campaigning (a little too quietly) for a rate cut of up to 10% on businesses. Even a more modest cut on the corporate tax rates would be a tremendous boost for job growth, give employees (especially unionized workers) excellent leverage to demand better health benefits with business expenses dropping that dramatically overnight, and disincentivize companies from moving their headquarters or pieces of holdings into tax havens overseas. With the kind of liabilities the federal budget will be taking on with the Big Deal and a Democratically held congress, that’ll be a hard sell. I, for one, wouldn’t cry foul if components of the Bush personal income tax rates were repealed to offset the costs (and, of course, would be glad to see reductions in spending outside of the military, infrastructure, and education budgets).
It’s pretty clear to me that one of the many reasons for this lousy economy we’re sitting in is the imbalance of profits in the financial sector as compared to the manufacturing and service sectors. I’d say we’ve been relying too much on the Fed to spur growth. It’s past time to get the broader economy working with a one-two punch of a business tax cut and a weak dollar to facilitate exports, while implementing policies to strengthen the dollar and get inflation under check.
[Later still: I swear I wrote all this before reading Kudlow's most recent column, which says most of the same things in the post-bullet portion of this post.
Also, this article by David C. John covers most of the things I wrote in the bullet-points, although more expertly than I did. A major difference is that he wants oversight by an independent board of financial experts with no ties to the Fed or Treasury. I still prefer my idea of absolute transparency and accountability to the "shareholders" also known as the American taxpayer. I think all government operations outside of the national security sector should be held to that standard. Another is that he doesn't mention any time limit for the acquisitions phase of RTC II, or whatever this thing'll be. I think that's an important requirement, both in ensuring that RTC II will go away eventually and in that it'll give it leverage in pricing—sell or die, to paraphrase Genghis Khan.]