The good, the bad, and the ugly

Brad DeLong says that Swedish-style temporary nationalization is the right answer to a financial crisis; he’s right. I haven’t been clear enough about this, it seems, but it’s where my basic diagnosis leads: the problem is insufficient capital, you want to inject capital, but you don’t want it to be a windfall to existing stockholders — hence, take over and recapitalize the failing firms. By the way, that’s what we did with AIG 10 years days ago.

So that’s the good solution. The Paulson plan, which is some combination of sheer giveaway and mystic faith that a slap in the market’s face will make everything OK, is a bad solution (and probably no solution at all.)

But nationalization doesn’t seem like a politically realistic answer now. This leaves the rough question of whether to hold out for a good solution, which won’t be possible until Jan. 21st, or accept the ugly compromise that the WH and the Congressional Dems, once again, say they’ve reached. It’s a tough call, but as I’ve written, I’ll probably hold my nose and say OK — as long as it has broad Republican support.

If not, go back to the good plan.

Comments are no longer being accepted.

Vasilis September 28, 2008 · 8:35 am

Prof. Krugman,

can you comment on the Zingales plan, laid out at
//www.voxeu.org/index.php?q=node/1670?

As others have mentioned, the diagnosis is similar, but the medicine different, and seemingly much less costly upfront than nationalization (and of course than the Paulson ex-plan). Does it do enough to solve the problem?

Mel Hauser September 28, 2008 · 8:41 am

In sum, this is a neurological problem (capital) and you feel compelled to let a gastoenterologist perform major surgery (liquidity) on the basis of a misdiagnosis. If you hold your nose long enough, you die–please don’t.

Tim Cole September 28, 2008 · 8:41 am

I know next to nothing about economics, but reading Kevin Phillips has made me aware of the “financialization” of our economy & that increasing reliance upon finance as opposed to manufacturing has historically been a symptom of national decline — he especially focuses upon the examples of Spain, the Dutch & the English in his book, Wealth and Democracy.

If Phillips is right, then I wonder what the long-term effect of all this will be? Regardless of the more immediate issues concerning frozen credit, is not the bigger pisture the fact that the bulwark of the U.S. economy has taken a major hit? Financial institutions whose existence we took for granted just a few weeks ago either no longer exist or are profoundly changed. It is hard for me to imagine that the taxpayers can “borrow” our way out of this. There must be considerable pain — either a bad recession or a depression just around the corner. Heaven help us!

creid September 28, 2008 · 8:46 am

One thing that bothers me about participating in the shadow banking system is that it would seem to then get the government “in for a dime, in for a dollar” to try to be made whole in an unregulated and greedy system that should Go Away.

How does the government become an honest broker, to coin a phrase? Does dealing into this system make it, well, just another broker?

How do we claw our way to integrity in a system the foundation of which is anything but?

Standing back from the dust and rubble, why won’t the government say, “OK, you’re playing by our rules now, you screwed up big time and now you’re going to toe the line or go belly up. Your choice.”

As soon as the government has skin in the game, will the government have financial motivation to want to avoid regulation and just wait a teeny bit longer so they can maybe get taxpayers’ money back?

In other words, is there a danger in taking possession of toxic securities that the government will adopt the mentality of the people they should have been regulating?

And about those firms rescued, pulled from the brink: will anyone be willing to be regulated until the next visit to the edge of the financial Niagara Falls?

I. don’t. think. so.

Kathleen in Florida September 28, 2008 · 8:57 am

They have been saying “The sky will definitely fall tomorrow” for 2 weeks now and it is still blue up there. How can we in our right minds trust Paulson or any other insider to this debacle?

The “Swedish solution” is looking pretty darn good to a taxpayer out here that knows nothing about economics and finance, but an awful lot about the frailties of man.

Doug Ward September 28, 2008 · 9:03 am

There’s this wierd vagueness to Paulson’s and Bernanke’s explanations. I can’t help wondering if the piece they don’t want to come out and just say is maybe that more than 100% of some mortgages has been sold and maybe some of the mortgages in some of the pools don’t exist at all. It would help explain why even after months of impending crisis, nobody seems to have figured out what percentage of the instruments they’ve issued are at risk. I mean, with a handful of people and a few weeks, you could take a pretty good sampling of any of these pools, if you were the issuer and you actually wanted to know…I’m just sayin’…

Arun September 28, 2008 · 9:45 am

To what extent is the crisis being manufactured?
Quote:

“Advocates for a rescue plan this week point to a seizing up of credit markets, reflected in elevated inter-bank lending rates, as reason for action. Some economists are unconvinced.

“I suspect that part of what we’re seeing in the freezing up of lending markets is strategic behavior on the part of big financial players who stand to benefit from the bailout,” said David K. Levine, an economist at Washington University in St. Louis, who studies liquidity constraints and game theory.”

Bruce Banister September 28, 2008 · 9:57 am

No, I don’t think going along with this is a good idea. It is patently a very bad idea. It is obvious to those of us who have been following the situation for years.

tom sj September 28, 2008 · 10:05 am

If the top echelon has no shame in taking a handout, foisting their bad debt on the American taxpayer, then why not the American taxpayer handing our debts right back! an unintended consequence of the abandonment of the last (smoking ruins) of our American ideals: “Meet your personal financial obligations!” How quaint!

Prediction: Americans will take out $700B worth of anger on mortgage companies and credit card companies and possibly the IRS. Why pay the banks when in good times and bad, they stuck it to us in excessive fees at usurious rates? Why pay taxes to make big payouts to big finance, big oil, big defense?

Garnish this! As the coming De-p Re–ssion wipes out wage income then what? Take our homes? (you have them) Our cars? (can’t afford to gas ’em) Jail? (oh that Constitution thing) An Executive Order nullifying the constitutional prohibition on intergenerational endentured servitude by reason of National Security?

The present day situation is remarkable only when viewed from a First World perspective, but unremarkable as events in the Third World where Leaders “by right” pilfer the country’s coffers and impoverish their people for generations to come. They have sold our children and our children’s children into servitude. They have eaten our young.

Welcome to the Third World!

Tom S. J.

Don the libertarian Democrat September 28, 2008 · 10:08 am

I am a libertarian Democrat. I don’t much like this bailout, but if we have to do it, I prefer the Swedish Plan because it worked and I understand it. I’ve been arguing for it all week on liberal and even libertarian blogs, including my own little blog. If people had gotten behind this earlier, we might have gotten it.

Stephane September 28, 2008 · 10:12 am

Who will determine the correct total amount of capital to be invested in the finance industry? and how?

James Kroeger September 28, 2008 · 10:23 am

This desperate, all-out effort to save Wall St. is a travesty of justice. The medicine being prescribed at extraordinary cost is nothing more than a Resuscitation Hope that ultimately seeks nothing more than to continue—and thus reward—a failed financial model.

Why is it so important that this corrupted mess survive? Are they trying to tell us that a privately-owned banking sector driven by profit-hungry risk takers is the only kind of banking system that can give us prosperity? Well, we know that isn’t true. Look at China’s astounding 35+ years of uninterrupted economic growth. It seems their state-owned banking sector has been able to accommodate all of the monetary needs of their extraordinarily dynamic economy.

I’m not saying we should copy China’s approach to banking. I’m just saying that it is insanity for us to settle for a failed approach to providing our economy’s need for loanable funds. Why should we ever again tolerate being subjected to economic terror like this? Why should we ever again put ourselves in a position where the rich manipulators of Wall St. are able to blackmail us into paying them a huge ransom, or else their going to blow up the whole economy?

One thing that a Taxpayers’ Bank would be able to provide to Main Street is all of the loanable funds that private banks are unable to lend at this time because of the mess they got themselves into. A Taxpayers’ Bank—owned and capitalized by the taxpayers—would fill the role of a ‘heart-lung machine’ that the patient can be hooked up to while blood flow is cut off to the damaged heart and repairs are carried out. Main Street would hardly notice the absence of the private banks.

Once the collapse bottoms out, the survivors will be in a position to start lending again, at a much lower level. They (or that single bank) should feel free to borrow and lend money again, perhaps finding a niche in the more risky sorts of customers. At such a time, Congress will have to finally decide to either re-privatize the Taxpayers’ Bank (for some insane reason I can’t think of) or simply continue with a mix of public and private banking.

Lynda Jones September 28, 2008 · 10:28 am

Thank you, Mr. Krugman. This is exactly what I’ve been looking for. I agree that this would be the better approach.

I am pessimistic about this bailout. I think that, while it may contain the problem for a period of time (which I believe will not be lengthy), the problems festering beneath our economy will continue to ripple, emerging as yet another crisis.

Can you work to build a consensus for this approach? Wonkish analysis is good for developing an economic history of this period, but we need you on the frontline devising a plan that will work. “If you build it, they will come.”

Mike Dolinski September 28, 2008 · 10:34 am

So then economic theory is diverted and ‘steered’ by political considerations? I wonder how the difference could be quantified and costs then assigned by social/income group?

Ok, I admit I am still perplexed but I wonder what the “Chicago School” would have to say to all this, and isent there a place for some downward flexibility here :)?

dlr September 28, 2008 · 10:39 am

What’s wrong with simply pushing insolvent banks into bankruptcy and selling their assets to a bank with responsible management and a strong balance sheet? Rumor has it that there are plenty banks out there that didn’t get caught up in the whole mortgage frenzy. Why can’t the takeover of WaMu this week be a template to solve the entire problem?

If the FDIC can be pushed to close down the banks too weak to lend, and sell their assets to banks that are still sound, it seems like the whole crisis would be over. The key of course would be to sell the assets at a price a willing buyer would be willing to spend, but if they managed to do that at WaMu, there has got to be hope. It’s hard to believe that any other banks actual balance sheet is further underwater than WaMu’s was. The shareholders and bondholders get wiped out of course, but, surely that is better than the US taxpayer taking the hit.

John Karevoll September 28, 2008 · 10:44 am

So: The quality of this decision-making is trumped by the politics of this decision-making. We’re in trouble.

Alice Dubiel September 28, 2008 · 10:53 am

I am so grateful for your visibility and opinions these two weeks. Right now we need economists (preferring the Keynesian flavor), not financiers. Shame is not part of my emotional glossary, but I am grateful my late mother, an accountant, is not alive to endure another economic meltdown due to the same power scheme mentality.

Gerda September 28, 2008 · 11:07 am

Dear Professor Krugman,
We need nationalization. If the word is unpalatable, change it. Let’s “Americanize” the banks. Or to emphasize the temporary character of nationalization, give the banks a “time out.”
Or a Western motif – “Corral the banks.”

Courtney L. Frobenius September 28, 2008 · 11:07 am

Could it be that the “bailout plan,” whether it be good or bad, is no bailout plan at all? Could it be that nothing will be bailed out until the underlying fundamentals are addressed?

Burgeoning national debt, a widening unfavorable balance of trade, dependence on foreign energy sources, lack of a national healthcare system, an out-of-control defense budget, two foreign wars, a decayng infrastructure . . . ad naseum. Could it be that until these fundamentals are addressed there will be no “bailout”?

Jaime Lima September 28, 2008 · 11:08 am

Should (or Can) the Government speculate against (or in favor of) itself? When Gov intervenes and buys those tainted financial instruments, it surely makes their actual prices get higher than they would be otherwise. What would prevent to interfere again in the markets in the future, let’s say forcing house to revert house prices to revert its nominal downward trend for a while, and ‘sell the recycled toxic mix back to the markets’ and book an apparent huge profits? Uncle Gov recruitment department would have any problem finding people available with experience in creating these type mechanisms these days. Just do not put them to work together with the people from the Inflation Control department.

I wish Ronald Reagan were alive in order to record a CD to tell us about us more about this plan and the dangers of ‘socialized finance’.

troy September 28, 2008 · 11:10 am

Is part of the reason why Spitzer got nailed at such a convenient time was to prevent him from attacking the CEO compensation packages that ultimately have come to surface with the rotted mortgage back assets ? Such a convenient time to do so …

Argentina 2001 – banks were closed, peso unlocked against it’s false over-peg to the dollar, and 225 billion of defaulted loans ->

-> Is America, a nation of 300 million not 30 million like Argentina, really looking at a requirement of 3 x 700 billion or do we need to see how far our dollar really has to fall from it’s current FALSE peg standing ??

Matt Stillerman September 28, 2008 · 11:25 am

We can only afford to do this once (if that). So, we get just one shot. That’s a good reason to hold out for the “good” plan.

Daniel Kwiat September 28, 2008 · 11:30 am

I am very disappointed that Prof. K will hold his nose and support this plan.

The plan is a trap: once the securities are bought–by the way, what qualifies a mortgage backed security for govt purchase is unspecified–we own them; once the 700B is spent, it is spent. And there is no guarantee that in the future that the US will be able to sell treasuries and raise 700B as cheaply as we can now. It is possible that the Paulson Plan won’t work, AND we will have to pay higher rates on Treasuries to raise more funds for Plan B.

So I submit to all: we need a plan that addresses household debt as well as bank capital.

What I would like to see is quite simply a grant to every adult citizen of $5000, which for citizens under the age of 70, can be put only towards debt repayment or a 3 year Bank CD (or some of both), and for citizens age 70 and over, could be cashed.

The rationale for this scheme is that for households as well as for banks, the ratio of “equity” to debt is crashing, and that a plan that boosts household equity and reduces household debt can also do the same for banks.

The public must beware that passage of the current Paulson Plan risks binding the hands of our future President–which, frankly, might be just the secret intent.

James Kroeger September 28, 2008 · 11:39 am

This desperate, all-out effort to save Wall St. is a travesty of justice. The medicine being prescribed at extraordinary cost is nothing more than a Resuscitation Hope that ultimately seeks nothing more than to continue—and thus reward—a failed financial model.

Why is it so important that this corrupted mess survive? Are they trying to tell us that a privately-owned banking sector driven by profit-hungry risk takers is the only kind of banking system that can give us prosperity? Well, we know that isn’t true. Look at China’s astounding 35+ years of uninterrupted economic growth. It seems their state-owned banking sector has been able to accommodate all of the monetary needs of their extraordinarily dynamic economy.

I’m not saying we should copy China’s approach to banking. I’m just saying that it is insanity for us to settle for a failed approach to providing our economy’s need for loanable funds. Why should we ever again tolerate being subjected to economic terror like this? Why should we ever again put ourselves in a position where the rich manipulators of Wall St. are able to blackmail us into paying them a huge ransom, or else their going to blow up the whole economy?

One thing that a Taxpayers’ Bank would be able to provide to Main Street is all of the loanable funds that private banks are unable to lend at this time because of the mess they got themselves into. A Taxpayers’ Bank—owned and capitalized by the taxpayers—would fill the role of a ‘heart-lung machine’ that the patient can be hooked up to while blood flow is cut off to the damaged heart and repairs are carried out. Main Street would hardly notice the absence of the private banks.

Once the collapse bottoms out, the survivors will be in a position to start lending again, at a much lower level. They (or that single bank) should feel free to borrow and lend money again, perhaps finding a niche in the more risky sorts of customers. At such a time, Congress will have to finally decide to either re-privatize the Taxpayers’ Bank (for some insane reason I can’t think of) or simply continue with a mix of public and private banking.

Please don’t tell me that no economist has ever thought of such an approach. Why was it ever rejected?

Paul Dorell September 28, 2008 · 11:43 am

It would be interesting to know whether the outright nationalization of financial corporations was considered by Paulson. Besides Paulson’s presumed preference for market-based solutions to business crises and the political riskiness of undiluted socialistic governmental actions, nationalization would create a whole new set of legal and legislative issues. What criteria would be used to nationalize a company that wasn’t at or near bankruptcy? What rights would shareholders have if a solvent and liquid company were nationalized? If you accept that a major collapse of the financial markets is imminent, a revolutionary new body of legislation that would instantly transform our economic system is simply not realistic.