« Fed Watch: The Beginning of Another Wild Ride | Main | It Wasn't the Community Reinvestment Act »

Monday, September 22, 2008

Paul Krugman: Cash for Trash

The Paulson plan is not acceptable in its present form:

Cash for Trash, by Paul Krugman, Commentary, NY Times: ...Henry Paulson’s $700 billion rescue plan for the U.S. financial system..., as far as I can see, doesn’t make sense. ...[And] what, exactly, in the experience of the past year and a half — a period during which Mr. Paulson repeatedly declared the financial crisis “contained,” and then offered a series of unsuccessful fixes — justifies the belief that he knows what he’s doing? ...

So let’s try to think this through for ourselves. I have a four-step view of the financial crisis:

1. The bursting of the housing bubble has led to a surge in defaults and foreclosures, which in turn has led to a plunge in the prices of mortgage-backed securities...

2. These financial losses have left many financial institutions with too little capital — too few assets compared with their debt. ...

3. Because financial institutions have too little capital relative to their debt, they haven’t been able or willing to provide the credit the economy needs.

4. Financial institutions have been trying to pay down their debt by selling assets,... but this drives asset prices down and makes their financial position even worse. This vicious circle is what some call the “paradox of deleveraging.”

The Paulson plan calls for the federal government to buy up $700 billion worth of troubled assets... How does this resolve the crisis?

Well, it might — might — break the vicious circle of deleveraging, step 4... Even that isn’t clear: the prices of many assets, not just those the Treasury proposes to buy, are under pressure. And even if the vicious circle is limited, the financial system will still be crippled by inadequate capital.

Or rather, it will be crippled by inadequate capital unless the federal government hugely overpays for the assets it buys, giving financial firms — and their stockholders and executives — a giant windfall at taxpayer expense. Did I mention that I’m not happy with this plan?

The logic of the crisis seems to call for an intervention, not at step 4, but at step 2: the financial system needs more capital. And if the government is going to provide capital..., it should get what people who provide capital are entitled to — a share in ownership, so that all the gains if the rescue plan works don’t go to the people who made the mess in the first place. That’s what happened in the savings and loan crisis... It’s also what happened with Fannie and Freddie. ...

But Mr. Paulson insists that he wants a “clean” plan. “Clean,” in this context, means a taxpayer-financed bailout with no strings attached — no quid pro quo on the part of those being bailed out. Why is that a good thing? Add to this ... that Mr. Paulson is also demanding dictatorial authority, plus immunity from review “by any court of law or any administrative agency,” and this adds up to an unacceptable proposal.

I’m aware that Congress is under enormous pressure to agree to the Paulson plan in the next few days, with at most a few modifications... Basically, after having spent a year and a half telling everyone that things were under control, the Bush administration says that the sky is falling, and that to save the world we have to do exactly what it says now now now.

But I’d urge Congress to pause for a minute, take a deep breath, and try to seriously rework the structure of the plan, making it a plan that addresses the real problem. Don’t let yourself be railroaded — if this plan goes through in anything like its current form, we’ll all be very sorry in the not-too-distant future.

    Posted by on Monday, September 22, 2008 at 12:42 AM in Economics, Financial System, Policy | Permalink  TrackBack (0)  Comments (117)

    TrackBack

    TrackBack URL for this entry:
    https://www.typepad.com/services/trackback/6a00d83451b33869e2010534c2251b970c

    Listed below are links to weblogs that reference Paul Krugman: Cash for Trash:


    Comments

    Feed You can follow this conversation by subscribing to the comment feed for this post.