Every Consensus Must End

The prevailing consensus on any economic policy is a fascinating beast.  For years it can stay put, seemingly immovable, and even – in some cases – becoming enshrined in legislation or central bank statute.  One day it begins to shake, ever so slightly; under the pressure of events, a wider range of serious opinion develops.  And then, all of a sudden, the consensus breaks and you are running hard to keep up.

We saw this last year with regard to discretionary fiscal policy – fiscal stimulus – in the US.  Eighteen months ago, very few mainstream economists or other policy analysts would have suggested that the US respond to the threat of recession with a large spending increase/tax cut.  The consensus – based on long years of experience and research – was that discretionary fiscal policy generates as many problems as it solves.  To argue against this consensus was to bang your head against a brick wall, while also being regarded as not completely serious.

At some point in November/December 2007, this consensus began to shake.  The history may prove controversial but my perspective at the time and in retrospect is that Marty Feldstein was the first heavyweight economist to question the consensus (including in interactions on Capitol Hill), and he was followed closely by Larry Summers’ influential writings in the Financial Times.  Within a month or so, the consensus broke.  Not only did we get a fiscal stimulus in early 2008 for the US, but the IMF quickly adopted the same pro-stimulus line globally and the terms of the debate changed everywhere.  This fed into a process out of which came at least a temporary new quasi-consensus: a large US fiscal stimulus is part of the sensible policy mix today.

The consensus on banking just broke cover.  For some weeks it has been under intense pressure.  At least since the fall, serious people have been informally floating various new ideas on how to deal with the technical problems surrounding toxic assets and presumed deficient bank capital.  But since mid-January, the mainstream consensus – that we should protect existing large banks and keep them in business essentially “as is” – seems to have cracked.

Paul Romer and Willem Buiter favor an approach that emphasizes the creation of new banks. Roger Farmer wants to go in a completely different direction.  These are just a few examples of the great (and completely constructive) new dispersion of ideas around banking – post links to your favorite new ideas in comments below.

Advocates for the previous consensus – and the status quo – seem to be located mostly in the financial sector itself (e.g., Lloyd Blankfein).  The Administration’s view, as I discussed with Bill Moyers last week, is apparently still up for grabs.  And I understand “what next” for banks will be a central theme for debate among staffers on Capitol Hill this week.

On the technical details, I could support any number of schemes.  My main concern is limiting taxpayer downside and making sure the taxpayer gets as much upside participation as possible.  We have a proposal on the table, but other ideas have merit and the US debate in this regard seems likely to be productive – in striking contrast with Europe, where denial is still the name of the game.

There is only one point on which I would insist.  The banking lobby has become too powerful, in large part because big banks have balance sheets that are too big relative to the size of the economy.  If a bank has total assets of over 10% of GDP, it is obviously too big to fail.  Of course, the smart people who run these banks know this and act – politically and economically – accordingly.

We need a strong system of financial intermediation, and this must feature people willing to take risks with their own capital.  In that context, there may be efficiency arguments in favor of relatively large deposit-taking/lending banks (although I’m far from convinced), but it is the political economy considerations that are overwhelming.  When all is said and done, if we still have large banks with great political power, we will eventually find ourselves in even bigger trouble.

Originally published at the Baseline Scenario and reproduced here with the author’s permission.

One Response to "Every Consensus Must End"

  1. PAUL94611   February 17, 2009 at 7:01 am

    Although I realize that this is not a be all, end all solution, most of us realize the problems that beset the banking industry are diverse and immense. One of the more potentially proactive solutions to address portions of the housing sector was recently discussed at Institutional Risk Analytics in an article titled “Can We Fix the Banks, Help Homeowners, and Rebuild the Mortgage Markets? Can Do”.There are a number of noteworthy possibilities addressed that are worth a broader discussion. Especially the Wall Street centric models that have been employed thus far and the role Community Banks have to play in “Fix Housing, Fix the Banks and the Securitization Markets Both”.http://us1.institutionalriskanalytics.com/pub/IRAstory.asp?tag=340