Economists are not famous for agreeing with each other. (“The First Law of Economists: For every economist, there exists an equal and opposite economist. Second Law: They’re both wrong.”)
So it is striking that publicly expressed opinions among non-Wall-Street economists on the Paulson/Frank plan range basically from former-Wall-Streeter Henry Blodget’s “it stinks” to Luigi Zingales’s “it will destroy the capitalist system for the next 50 years.” (Zingales is worried about the moral hazard problem). The only other common and prominent public point of view is Greg Mankiw’s “Ben Bernanke is a very smart guy who knows more than I do, and if he says we have to do it then maybe we have to do it.” But even Mankiw seems to have grave doubts, and a lot of economists suspect that Bernanke actually thinks it’s a bad deal too; he has looked awfully pale and has taken a conspicuously deferential and back-seat role to Paulson in his public comments (see Robert Shimer’s reply to Mankiw). My own best guess is that Bernanke’s deep regard for the constitutional structure of the government has led him to conclude that it is not his role as Fed chief to undercut the Treasury secretary even if he thinks the Paulson plan is a bad one.
(In addition to this long and ideologically diverse list of economists opposed to the initial plan, prominent recent critics include Ronald Reagan’s Council of Economic Advisers chair and emeritus President of the National Bureau of Economic Research Martin Feldstein as well as Democratic economists from former Fed Vice Chair Alan Blinder to Bill Clinton’s Council of Economic Advisers chair (and subsequent Nobel laureate) Joseph Stiglitz writing in The Nation to the middle-of-the-road Brookings economist Douglas Elmendorf to leftish gadfly James K. Galbraith to former CBO chief economist Debby Lucas to Paul Krugman to former Clinton Administration official and economist-blog-king Brad deLong.).
The fact that this near unanimity seems to have had little effect in slowing down the bailout train wreck brings to mind Alan Blinder’s famous observation that “Economists have the least influence on policy where they know the most and are most agreed; they have the most influence on policy where they know the least and disagree most vehemently.” (It’s those vehement disagreements that gives us the reputation that is being mocked in my opening paragraph).
In talking to people involved in the inside-baseball political side of the discussion on Capitol Hill, I get the impression that they are very unhappy about being asked to sign on to this bill, but are planning to do it because they have been told that if they don’t, the apocalypse is around the corner.
The key point that I think is not penetrating from the economists to the Congress is that what sticks in our craw is ONE SPECIFIC ASPECT of the Paulson/Frank plan: Its focus on having the government buy up the toxic subprime securities. This may well prove to be almost a pure bailout for Wall Street, and there is no reason that any of us sees that this has to be the core of the rescue plan. I think you could get near-unanimity from economists, from across the political spectrum, in favor of a simple, easy-to-do alternative that would be both more economically sound and more politically palatable: The Federal government should do, with respect to the banking sector as a whole, what Warren Buffett did last week in his investment in Goldman Sachs.
Buffett did not become the richest man in the world by making bad investments. The money he provided to Goldman was emphatically NOT a bailout. It was a prudent investment – he thinks he will make his money back, and much more. The taxpayer should follow his lead and take a similar stake in the financial industry.
This is the essence of the concrete plans that conservative, moderate, and liberal economists have been proposing (cf. Zingales and deLong). I think the reason these ideas have not made more headway on Capitol Hill is simply that the proposals are written in terms that are too technical for members to realize that they are all basically saying the same thing: The right way to recapitalize the financial system is by investing money in the system as a whole, so that the taxpayer benefits when the economy recovers. This is not a new idea; it is basically what Sweden did in 1992 when it faced a financial meltdown, and it worked out OK in the end for the Swedish taxpayer (at least compared with the alternatives). Just like Warren Buffett, the taxpayer might even ultimately make money on the deal.
At the risk of making eyes glaze over, let me sketch one way of doing this (which is basically similar to the more concrete and detailed proposals of others): The taxpayer could approach each financial institution that is in trouble and offer them a take-it-or-leave it deal: You need capital and we have capital. We’ll either lend you the money you need (in exchange for being first in line for repayment out of any future profits, and in exchange for your cutting your dividends to zero until your capital is restored), or we’ll buy preferred shares in you in an amount directly proportional to shareholder equity from your last audited financial statement (again, you must cut dividends to zero until you are healthy again). This solution is not perfect, but I am assured by people who should know that it is something that could be organized very quickly and would provide the needed capital. The plan would need to specify, in an ironclad way, that the taxpayer’s stake would be sold off (at a profit) when the system regains its footing.
What is mystifying to me and many other economists is why there seems to be such resistance to the Zingales/deLong/Buffett plan by people who do not seem to be able to offer a coherent rational argument for why it would not work, and an insistence instead that the taxpayer should buy the toxic assets directly. I can think of only one potential explanation: A rigid ideological opposition on the part of Henry Paulson to taxpayer ownership of even one dime of the financial sector. If this is the right explanation, it is scarily reminiscent of the rigid ideologies that led to catastrophic errors of policy judgment during the Great Depression. A lot of conservative economists, who share Paulson’s presumed predilictions in this regard, have seen the light and now feel that the Zingales/deLong/Buffett plan is the best of a bad set of options. Why doesn’t Henry Paulson agree?
(I should note, in fairness, that Paulson has moved somewhat in this direction; the latest versions of his plan involve taxpayers getting some ownership stake in exchange for their purchases of the toxic assets. But if he is willing to compromise in that regard, it is all the more mysterious that there is still an insistence on buying the toxic assets).