Tuesday, September 30, 2008

Fred Thompson on the Bailout Plan

For the last week or so, I have been following the comments on the bailout/rescue plan on BlueOregon and Oregon Catalyst, which reflect local left/right thinking. The comments have been running 10/1 against. And, presumably, this has something to do with the negative votes of the majority of the folks in our congressional delegation. However, most of the comments just don’t make sense. They remind me of Howard Beale standing up during the middle of his newscast crying, "I'm as mad as Hell, and I'm not going to take this anymore!"

The Paulson Plan is quite simple. Both the Fed and the Treasury see the immediate problem as one of monetary contraction. As the value of bank assets drop, so too does their ability to extend credit. Why is the value of their assets dropping? No one knows what they are worth, so they aren’t worth much. Buyers won’t sell; sellers won’t buy except at extremely distressed prices.

If the immediate problem is preventing monetary contraction, the solution is to buck up bank balance sheets. That can be done by swapping T-Bills for the commercial. Moreover, if the Treasury makes the swaps by reverse auction they will also jump-start the market for the assets not offered for sale. It should work.

What are the disadvantages of this plan (all plans have disadvantages – there are no free lunches)? One is stressed by libertarian monetary theorists like many of the 200 signers of the economists’ petition against the bailout: the monetary /banking system is prone to excess, because it is so interconnected, politically responsive (corrupt), and debt dependent. We ought to let the market sort things out. If it takes a depression, so be it. We’ll be better off as a result. This view has some merit, but I’d prefer not to run the risk.

On the other hand, folks like Paul Krugman want to go even further than Treasury. Rather than relying on open market operations, something the Treasury knows how to do. They want the Treasury to take an equity position in failing banks as the Swedes have or Treasury did with Fanny-Mae and Freddy-Mac. This would minimize the risk to the public fisc, but probably also deter private investors from making investments in this sector.

The Paulson plan does not rule out this option, but neither does it require it. It is a sensible, prudent middle-of-the-road proposal.

In the mean time, three cheers for Darlene Hooley. It is nice to be represented by an adult.

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