Jay P. Greene's Blog

Greg and Matt had some excellent posts yesterday on the bailout.  Matt described how we got into this mess and Greg outlined the issues in dispute.  Today I want to talk about where we go from here.

I do not believe that a Congressional bailout is necessary to avert a catastrophe nor do I believe that it will effectively stop the economic damage that remains to be inflicted.  All that Congress is likely to do is shift the cost of the economic damage to a broader pool and hinder future growth with unwise regulations and new programs.

Despite scare-mongering to rush a bill through Congress, the reality is that the current turmoil is a normal popping of a speculative bubble fueled by Fannie and Freddie (government) guarantees on mortgages and artificially low Federal Reserve interest rates.  No matter what Congress does, a fair number of people are in homes they cannot afford and a number of banks own mortgages that will never be repaid. 

Shifting those bad mortgage securities from financial institutions to the government balance sheet changes nothing.  Someone is going to have to eat those losses.  If the bailout pays the banks above the market value for those securities, then the taxpayers will bear those losses, either in the form of raised taxes or higher inflation.  If the bailout pays market value, then the banks will not have any additional capital on their books and they will be no better off.  Either way, the economic damage of these bad mortgage securities on the economy will remain the same.

The only way that the government bailout could help is if the government pays above market value for the mortgages, strengthening bank balance sheets, but the amount that is paid turns out to be less than the intrinsic value of those securities, so the mortgages can later be resold without a loss to taxpayers.  But there is no reason to believe that the market value of those securities is less than their intrinsic value or that the government knows what the true intrinsic value of those securities is and will pay less than that amount.

To believe the case for the bailout you would have to believe that the government is the smartest hedge fund out there.  Keep in mind, there are potential buyers with capital willing to buy the bad mortgage securities, but not at a price that banks are currently willing to sell.  The banks don’t want to sell for the price that buyers would buy because they would have to write down the losses and be forced to raise capital themselves, which they are currently unable to do easily.  Instead, the banks are holding on, hoping that the government will pay them a higher price or that the market for these mortgages will somehow improve.

Instead of a bailout we should allow the market to work out these losses.  The government cannot stop the losses; it can only move them around.  And it can do some extra damage in the process, such as imposing new regulations and introducing moral hazard for future financial mistakes.

Despite elite opinion in the media and from many on Wall Street that a bailout is necessary, the passing of each day without a catastrophe demonstrates otherwise.  Sure, the markets have been volatile, but short-term market movements don’t indicate the long-term wisdom of policies. 

And let’s put things in perspective.  The economy grew last quarter.  Credit-worthy consumers can still get mortgages, car loans, and business loans.  The stock market is still higher than where it was a decade ago.  Things are painful but they are not catastrophic.

As Peter Robinson over at National Review’s The Corner says, “it has become impossible—simply impossible—to dismiss opponents of the bailout as mere hayseeds and (what to a lot of people amounts to the same thing) House Republicans.”  And a group of 200 academic economists from all ends of the political spectrum have come out against the bailout.

The hardest thing to do in a moment of crisis is to do nothing.  But in this case nothing is probably exactly what we need.

Update:  Alan Reynolds has a great piece at Forbes in which he documents that consumer lending has not declined.  He writes:

“On CNBC Monday, Democrat majority leader Steny Hoyer said the objective of the rescue package is to “unlock the credit” for consumers and business. And a Wall Street Journal editorial writer told CNBC, “Until we get the banks lending again, the economy will continue to contract.”

Such alarming comments never mention any facts. Why not? As Neil Cavuto recently noted on Fox Business News, the Fed reports bank loans every week.

U.S. Bank Loans (Billions of Dollars)

Federal Reserve Board, “Asset and Liabilities of Commercial Banks in the United States” (H.8).

In August, bank loans to consumers were 9.5% higher than they were a year earlier–the fastest increase since 2004. The year-to-year increase in consumer and industrial loans was 15.5%, down only slightly from a recent record high of 21.6% in March. Real estate loans were up 4.1% for the 12-month period ending this August–flat lately, but not down…

Contrary to many comments, consumer and industrial loans actually increased in the latest week. Troubled giant banks have cut back on lending, but smaller banks have picked up the slack. Consumer and real estate loans dipped insignificantly through Sept. 17, remaining much higher than they were a year earlier. “