From the book “Restoring Financial Stability: How to Repair a Failed System”. Section VI: The Bailout
Background The massive US Government bailout originally intended for the financial industry has now spread to the non-financial sector, and the government is considering bailing out car manufacturers. This is partly the fault of the financial bailout itself, which was poorly designed and too generous to the financial industry. Unfortunately, history and political economy have taught us that ad-hoc government interventions to bail out industries are a recipe for long run economic stagnation. This does not mean, however, that the government should stay on the sidelines. We propose a set of principles for efficient interventions, and we show how these principles apply in the case of General Motors.
From the book “Restoring Financial Stability: How to Repair a Failed System”. Section V: The Role of the Fed
Background Systemic risk is the risk that the failure and distress of a significant part of the financial sector reduces the availability of credit which in turn may adversely affect the real economy. Not all economic downturns involve systemic risk, but the occurrence of systemic risk has almost invariably transformed economic downturns into deep recessions or even depressions. Such systemic risk has been ubiquitous in the current crisis. It has manifested itself in the moral hazard encouraged by “too-big-to-fail” guarantees, in the externalities created by deleveraging, fire-sales, hidden counter-party risk and liquidity shortages, and in the aggregate decline in home prices.
Employees of the financial industry have enjoyed very high compensation in recent years. The bonuses of Wall Street reached more than $200,000 per employee in 2007. Bonuses fell in 2008 but remain surprinsingly high in light of the industry’s dismal performance. So, are bankers over-paid?The history of wages and human capital in the US financial sector turns out to be quite fascinating. Before I spoil the suspense by showing you what actually happened, ask yourself what one should expect. Here are a few hypotheses:
The massive US Government bailout originally intended for the financial industry has now spread to the non-financial sector, and the government is considering bailing out car manufacturers. This is partly the fault of the financial bailout itself, which was badly designed and too generous to the financial industry. Unfortunately, history and political economy have taught […]
In 2006 (long before the crisis started), I was working on a project to understand the evolution of the U.S. financial industry. I concluded that its growth seemed to reflect fundamental economic needs up to 2001, but that it was not clear (at least to me) why it kept growing so quickly after 2002.Based on my simple model, I thought the financial sector was about one percentage point of GDP too large (on the virtues on simple models, see Krugman). In April 2008, in an interview with Justin Lahart of the WSJ, my idea was translated in the following way: “Mr. Philippon argues that the surge of financial activity that began in 2002 created an employment bubble that is now bursting. His model suggests total employment in finance and insurance has to fall to 6.3 million to get back to historical norms, and that means losing an additional 700,000 jobs in the sector.” In truth, my model is not about the number of jobs but about the GDP share, so it would be more accurate to say that the annual wage bill of the financial sector needs to shrink by approximately $100 billion.