James Galbraith on the Financial Crisis

First in Harper's:

5. The Democrats say they are not going to give the administration a blank check, but there’s a lot of pressure to do something. What sort of conditions should be attached to a bailout?

The Democrats have a strong hand. The voters weren’t born yesterday; they understand that it’s a Republican administration in power. Some of the problems are difficult to solve. Executive compensation is clearly a legitimate concern; it’s incredible that Lehman Brothers set aside a $2.5 billion bonus pool as it was going into bankruptcy. On the other hand, what do you do about it? If you tell these people they have to work for $400,000 a year–that’s a lot of money to you and me, but a lot of them are going to say, “See you on the ski slopes, pal.” But what Congress can do is make sure the companies have to turn over any information that the Treasury wants from the companies, including the computer code. If the government is going to buy assets of dubious value, it needs to know that the companies aren’t selling it the worst of the worst, just as you have the right to inspect a used car before buying it.

6. How long is it going to take to fix the situation? And what about the bigger financial crisis?

There’s nothing that can put this right in six months. No bailout can achieve that, but the difference between three years and ten years is important. The Treasury is going to end up with a large portfolio of properties. The government needs to set up the equivalent of draft boards in communities to make a review of properties and see how to keep people in their homes: offering them sustainable payments or converting mortgages into rental contracts, or simply demolishing homes that have been wrecked or that have fallen into irreparable disrepair.

Also in The American Prospect:

Many are concerned with the fiscal implications of this bill, so let me turn to that question. Despite the common use of language, the capital cost of this bill does not involve "taxpayer dollars." It authorizes a financial transaction, exchanging good debt (U.S. Treasury bills and bonds) for bad debt (the "troubled assets"). Many of those troubled assets will continue to earn income for some time, perhaps a long time. The U.S. Treasury commits itself to paying the interest on the debts it issues. The net fiscal cost -- which is also the net fiscal stimulus -- of this bill is the difference between those two revenue streams. Given the very low rate of interest presently prevailing on Treasury bills, this is likely to be somewhere between $20 billion per year and zero from the beginning, even if the Treasury were to issue all $700 billion in new debt at once. It is a mistake, in short, to count the capital cost as a "cost to the taxpayer." This is not the war in Iraq. In the longer run, of course the Treasury will incur capital losses on the assets it acquires. The entire purpose of the bill is to overpay for bad assets, so as to give financial institutions a chance to recapitalize themselves.

Comments

[Bryon]

Here's another analysis from the good folks at CEPR.net:

http://www.cepr.net/documents/publications/us_world_2008_09.pdf

[nzuckerman]

Though I admire both the son (the author here) and his famous father, there are any number of reputable economists who claim that the govt must fund a bailout to avert disaster. I am not knowing enough to assume that this one man is right and others perhaps mistaken. Many folks, and a number of economic thinkers, suggest that nothing ought to be done...

[Peter]

Some people say that the large banks SOLD the "good" and "fair" TRANCHES of the mortgage-debt and KEPT the "bad" TRANCH.

(TRANCH is fancy talk for a slice or division of something according to TRIAGE. TRIAGE is a fancy word meaning allocation of resources).

Makes sense, for who would (knowingly) buy the "bad" tranches from the large banks?

IF THIS IS SO, THEN the bailout is substantially intended to correct a CONSCIOUS POLICY of the banks, (i.e., holding the "bad" tranches"), not an ACCIDENT.

BTW, are bailouts to reimburse w.r.t. the COST to the applicant of the mortgage-securities, even if they were purchased for cents-on-the-dollar?

[Dave Ranning]

This from Stoneleigh is a must read for all you superstition based economists:

They had us all fooled there, didn’t they? Don’t be too hard on yourself, we all thought that Washington was discussing the economy. We were all wrong. They are talking about the laws of physics.

Later today, the US Senate will vote on a proposal to suspend gravity. For pigs.

Rumor has it that there is a bi-partisan effort going on, as we speak, to assess whether lipstick looks good on sheep. If the test turns out successful, gravity for them will also be lifted.

The reasoning behind the plan is that it will allow the government to make Americans believe that pigs can fly.

Once they believe that, the sky, obviously, is the limit. It is now widely understood that before the elections, all graphs pertaining to the US government and financial institutions will under law have to be viewed upside down. In addition, the Federal Reserve has demanded all red ink will be changed to black, and vice versa. Since the need for red ink has grown exponentially, and shortages are foreseen, all involved agree that this is a great idea.

Banks will be allowed to hold zero reserves. For the sake of fairness, the same will apply to all citizens. To stimulate acceptance of the new zero line, all deposits will be removed from bank accounts. After all, they won’t be needed anymore.

In return for their deposits, Americans will receive a computer model developed by a renowned Wall Street investment bank that will let them set a value of their choice for all assets they own.

Since the only thing really wrong with the economy is sentiment, the fact that every US citizen will live in a marked-to-model million dollar home by Christmas has raised expectations for the holiday shopping season to new record levels.

In initial talks, Europe is reported to be enthousiastic about the new legislation, though there are worries among French and German politicians that the population in their countries will be harder to convince that lipstick does indeed look good on sheep.

China is expected to be a harder sell. Since the Chinese eat far more pork per capita, there would be an unfair disadvantage for them related to the time spent trying to catch the pigs. Negotiations are ongoing.

[aguy109]

Dave,the fact is that many pigs can indeed fly if you pack them aboard a 747 (coach only, please). True, keeping them airborne requires a lot of fuel, but that's just what the US govt is providing. Markets are always based on things that are not directly quantifiable,like expectations, predictions, optimism and blinkered faith. These bailouts are certainly grossly unfair to the poor and to the many causes that are much more deserving, but if they work they will be regarded as a necessary evil.

[CriticalMassI]

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