Stiglitz: Bailout Blues

Joseph Stiglitz hopes we can tread water until a new administration takes over:

Bailout Blues, by Joseph E. Stiglitz, Project Syndicate: It doesn’t take a genius to figure out that the United States’ financial system – indeed, global finance – is in a mess. ...

As global markets plummet, ... Congress ... may rescue Wall Street, but what about the economy? What about taxpayers, already beleaguered by unprecedented deficits, and with bills still to pay for decaying infrastructure and two wars? In such circumstances, can any bailout plan work? ...

[T]he rescue plan that was just defeated ... remained critically flawed. First, it relied – once again – on trickle-down economics: somehow, throwing enough money at Wall Street would trickle down to Main Street, helping ordinary workers and homeowners. Trickle-down economics almost never works...

Moreover, the plan assumed that the fundamental problem was one of confidence. That is no doubt part of the problem; but the underlying problem is that financial markets made some very bad loans.

There was a housing bubble... That bubble has burst. House prices probably will fall further, so there will be more foreclosures.. The bad loans ... have created massive holes in banks’ balance sheets, which have to be repaired. Any government bailout that pays fair value for these assets will do nothing to repair that hole. ...

We could do more with less money. ... The Scandinavian countries showed the way two decades ago. .... By issuing preferred shares with warrants (options), one reduces the public’s downside risk and ensures that they participate in some of the upside potential.

This approach is not only proven, but it also provides both the incentives and wherewithal needed for lending to resume. ...

At the same time, several steps can be taken to reduce foreclosures. First, housing can be made more affordable for poor and middle-income Americans by converting the mortgage deduction into a cashable tax credit. ... Second, bankruptcy reform is needed to allow homeowners to write down the value of their homes and stay in their houses. Third, government could assume part of a mortgage, taking advantage of its lower borrowing costs. ...

There is a growing consensus among economists that any bailout based on Paulson’s plan won’t work. ...

But it is impossible for politicians to do nothing in such a crisis. So we may have to pray that an agreement crafted with the toxic mix of special interests, misguided economics, and right-wing ideologies that produced the crisis can somehow produce a rescue plan that works – or whose failure doesn’t do too much damage.

Getting things right – including a new regulatory system that reduces the likelihood that such a crisis will recur – is one of the many tasks to be left to the next administration.