Krugman Despairs

Paul Krugman is disturbingly convincing about the merits of Obama bank bailout plan:

But it’s immediately obvious, if you think about it, that these funds will have skewed incentives. In effect, Treasury will be creating — deliberately! — the functional equivalent of Texas S&Ls in the 1980s: financial operations with very little capital but lots of government-guaranteed liabilities. For the private investors, this is an open invitation to play heads I win, tails the taxpayers lose. So sure, these investors will be ready to pay high prices for toxic waste. After all, the stuff might be worth something; and if it isn’t, that’s someone else’s problem.

Or to put it another way, Treasury has decided that what we have is nothing but a confidence problem, which it proposes to cure by creating massive moral hazard.

This plan will produce big gains for banks that didn’t actually need any help; it will, however, do little to reassure the public about banks that are seriously undercapitalized. And I fear that when the plan fails, as it almost surely will, the administration will have shot its bolt: it won’t be able to come back to Congress for a plan that might actually work.

Krugman’s argument is so clear and straightforward that I have to assume Obama’s stable of geniuses has some answer to it. At least I hope they do. Given the crushing problems Obama inherited, he has a chance to be a Mt. Rushmore level president. If he blows it, I shudder to think what happens next.

See also Brad DeLong’s defense of the plan, and Krugman’s brief reply to DeLong.

Comments

  1. #1 Erik 12345
    March 22, 2009

    Romer thinks the criticism is unfair: http://www.huffingtonpost.com/2009/03/22/romer-krugmans-criticism_n_177727.html

    I guess she will have to elaborate if she wants to be more convincing than Krugman, though.

  2. #2 Tony
    March 23, 2009

    Krugman unhappy? That’s probably why the DOW and S&P futures are up tonight.

  3. #3 ArchAsa
    March 23, 2009

    @Tony
    Yes – because if it is one thing the last 12 months has taught us, it’s that the DOW is an accurate assesment of the state of the economy…

  4. #4 BaldApe
    March 23, 2009

    Obama’s stable of geniuses has an answer, but the answer is politics. A lot of the crisis is in confidence, and everything the government does undermines confidence in the banking system. It doesn’t seem likely that anybody will just let the banks fail, but the more they try to avoid it, the worse it gets.

    It’s Finagle’s Law: Once a job is botched, any attempt to straighten things out will only make matters worse.

  5. #5 Joseph Cassles
    March 23, 2009

    I think competent scientist and teachers could get the heat off of themselves, concerning the teaching of creationism, if they would just end every lecture or technical paper on evolution with, “And the God of Abraham and Isaac, creator of heaven and earth, Father of Jesus of Nazareth, made these miracles possible, gave me the eyes to see its truth, and the strength and wisdom to carry this message to his chosen flock.”

    “Because religious belief, or non-belief, is such an important part of every person’s life, freedom of religion affects every individual. Religious institutions that use government power in support of themselves and force their views on persons of other faiths, or of no faith, undermine all our civil rights. Moreover, state support of an established religion tends to make the clergy unresponsive to their own people and leads to corruption within religion itself. Erecting the,”wall of separation of church and state,” therefore, is absolutely essential in a free society.”
    ~Thomas Jefferson: Author of the Declaration of Independence; Third president of the United States of America; Co-Framer of the United States Constitution…………..

    ” Science without religion is lame, religion without science is blind.”
    ~Albert Einstein~

    “May we please have a moment of science, for those poor souls that cannot understand evolution as God’s scientific method.”
    ~Ned~

  6. #6 Chris Bell
    March 23, 2009

    I am no Nobel-prize winner, but the answer as I understand it is “Krugman is factually wrong.” As you quoted, he is arguing “this is an open invitation to play heads I win, tails the taxpayers lose.” This is just factually wrong.

    Imagine that you are a hedge fund. The government tells you, “If you put up $1 million, we will loan you $4 million. You can use this money to buy toxic assets. If you buy smart, then you will get most of the profits (after paying back the taxpayer plus interest). If you buy stupid, you lose your $1 million and we lose our $4 million.”

    It’s worth noting that the government agrees not to come after the investor for that $4 million. (If the hedge fund has $4 million in another account it is safe.) But it is still just incorrect to say that this is heads-I-win-tails-you-lose. The investor can still lose everything he puts in.

  7. #7 Chris Bell
    March 24, 2009

    I’ll add that I saw an interview with Krugman where he explained his position more. He argued that this is the same as the Paulson plan, it is just wearing a hat and funny glasses.

    In the Paulson plan, the government was going to buy these toxic assets outright. In the Obama plan, the government will “buy” the assets based on the recommendations of private investors who are willing to put some of their own money on the line.

    I guess that either way the government is buying the assets, but isn’t the distinction REALLY key? The government is harnessing the expertise of private investors in order to correctly price these assets. If the government did not do this, we would have political hacks trying to decide how much to pay.

  8. #8 Greg Esres
    March 25, 2009

    I don’t think that winning a Nobel prize suddenly makes one the only economist that knows anything. On the other hand, I’m skeptical that the forecasts of any economist are better than random chance would dictate. Nonetheless, we will eventually get out of the recession and the Obama team will claim credit for it and it will be tough to prove they’re not right. I’m sure Krugman will try.