More than 150 Academic Economist Sign Letter Against the Bailout

Hundreds of economists urge congress not to rush on rescue plan
Matthew Benjamin, Reuters Published: Friday, September 26, 2008

More than 150 prominent U.S. economists, including three Nobel Prize winners, urged Congress to hold off on passing a US$700-billion financial market rescue plan until it can be studied more closely.

In a Sept. 24 letter to congressional leaders, 166 academic economists said they oppose Treasury Secretary Henry Paulson's plan because it's a "subsidy'' for business, it's ambiguous and it may have adverse market consequences in the long term. They also expressed alarm at the haste of lawmakers and the Bush administration to pass legislation.

"It doesn't seem to me that a lot decisions that we're going to have to live with for a long time have to be made by Friday,'' said Robert Lucas, a University of Chicago economist and 1995 Nobel Prize winner who signed the letter. "The situation may get urgent, but it's not urgent right now. Right now it's a financial sector problem.''

The economists who signed the letter represent various disciplines, including macroeconomics, microeconomics, behavioral and information economics, and game theory. They also span the political spectrum, from liberal to conservative to libertarian.

Some lawmakers are already citing the letter as reason not to endorse Paulson's plan. Senator Richard Shelby, a Republican from Alabama, said yesterday he has "five pages of the leading economists in America that wrote to me and the leadership saying the Paulson plan is a bad plan. It will not solve problems. It will create more problems.''

The letter, initially conceived by economists at the University of Chicago, was signed by professors from dozens of American universities and several outside the U.S.

David I. Levine, a professor of economics at University of California-Berkeley, says the current plan being discussed has the wrong structure.

"The structure is designed for the Treasury to be the first line of defense,'' said Mr. Levine, who studies organizations and incentives. "A whole lot of people made money supposedly by putting their capital at risk, and those are supposed to be the first line of defense, that's how capitalism works.''

Jeffrey Miron, a Harvard University professor and self- described libertarian, objects to what he says is "a stunningly broad, aggressive government intervention without appropriate precedents.''

He advocates allowing the normal process of business failure and bankruptcy to run its course. "It's just nothing like the calamity the administration is making it out to be,'' he said.

Erik Brynjolfsson, of the Massachusetts Institute of Technology's Sloan School, said his main objection "is the breathtaking amount of unchecked discretion it gives to the Secretary of the Treasury. It is unprecedented in a modern democracy.''

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.

TheFuckOffKid said:
Thank you pete, one of your best posts ever.

There are some serious heavy-hitting names in there.

Commentary: Bankruptcy, not bailout, is the right answer

By Jeffrey A. Miron

CAMBRIDGE, Massachusetts (CNN) -- Congress has balked at the Bush administration's proposed $700 billion bailout of Wall Street. Under this plan, the Treasury would have bought the "troubled assets" of financial institutions in an attempt to avoid economic meltdown.

This bailout was a terrible idea. Here's why.

The current mess would never have occurred in the absence of ill-conceived federal policies. The federal government chartered Fannie Mae in 1938 and Freddie Mac in 1970; these two mortgage lending institutions are at the center of the crisis. The government implicitly promised these institutions that it would make good on their debts, so Fannie and Freddie took on huge amounts of excessive risk.

Worse, beginning in 1977 and even more in the 1990s and the early part of this century, Congress pushed mortgage lenders and Fannie/Freddie to expand subprime lending. The industry was happy to oblige, given the implicit promise of federal backing, and subprime lending soared.

This subprime lending was more than a minor relaxation of existing credit guidelines. This lending was a wholesale abandonment of reasonable lending practices in which borrowers with poor credit characteristics got mortgages they were ill-equipped to handle.

Once housing prices declined and economic conditions worsened, defaults and delinquencies soared, leaving the industry holding large amounts of severely depreciated mortgage assets.


The fact that government bears such a huge responsibility for the current mess means any response should eliminate the conditions that created this situation in the first place, not attempt to fix bad government with more government.

The obvious alternative to a bailout is letting troubled financial institutions declare bankruptcy. Bankruptcy means that shareholders typically get wiped out and the creditors own the company.

Bankruptcy does not mean the company disappears; it is just owned by someone new (as has occurred with several airlines). Bankruptcy punishes those who took excessive risks while preserving those aspects of a businesses that remain profitable.

In contrast, a bailout transfers enormous wealth from taxpayers to those who knowingly engaged in risky subprime lending. Thus, the bailout encourages companies to take large, imprudent risks and count on getting bailed out by government. This "moral hazard" generates enormous distortions in an economy's allocation of its financial resources.

Thoughtful advocates of the bailout might concede this perspective, but they argue that a bailout is necessary to prevent economic collapse. According to this view, lenders are not making loans, even for worthy projects, because they cannot get capital. This view has a grain of truth; if the bailout does not occur, more bankruptcies are possible and credit conditions may worsen for a time.

Talk of Armageddon, however, is ridiculous scare-mongering. If financial institutions cannot make productive loans, a profit opportunity exists for someone else. This might not happen instantly, but it will happen.

Further, the current credit freeze is likely due to Wall Street's hope of a bailout; bankers will not sell their lousy assets for 20 cents on the dollar if the government might pay 30, 50, or 80 cents.

The costs of the bailout, moreover, are almost certainly being understated. The administration's claim is that many mortgage assets are merely illiquid, not truly worthless, implying taxpayers will recoup much of their $700 billion.

If these assets are worth something, however, private parties should want to buy them, and they would do so if the owners would accept fair market value. Far more likely is that current owners have brushed under the rug how little their assets are worth.

The bailout has more problems. The final legislation will probably include numerous side conditions and special dealings that reward Washington lobbyists and their clients.

Anticipation of the bailout will engender strategic behavior by Wall Street institutions as they shuffle their assets and position their balance sheets to maximize their take. The bailout will open the door to further federal meddling in financial markets.

So what should the government do? Eliminate those policies that generated the current mess. This means, at a general level, abandoning the goal of home ownership independent of ability to pay. This means, in particular, getting rid of Fannie Mae and Freddie Mac, along with policies like the Community Reinvestment Act that pressure banks into subprime lending.

The right view of the financial mess is that an enormous fraction of subprime lending should never have occurred in the first place. Someone has to pay for that. That someone should not be, and does not need to be, the U.S. taxpayer.

bean said:
Um. Guys, you know this is referring to the 3-page proposal put forth last week by Henry Paulson, not the bill that passed the Senate tonight, and that some of the reasons behind signing the letter are either already outdated or, in hindsight, not exactly correct, right?

Like this:

Between the 24th and today, it has gotten urgent, with the pain spreading from Wall Street to small businesses, consumers, and municipalities, as credit lines dry up, home equity lines are closed off, and short-term loans are denied.

In its original form, the plan had no oversight whatsoever. It specifically excluded Congress and the courts from any oversight abilities. That was removed, and replaced with a plan for bipartisan oversight and a gradual release of funds, with the future release of chunks of the funds requiring congressional approval or executive order. That's a pretty massive difference that wasn't there when this letter was formed.

From the letter:

The original proposal was three (THREE!!!) pages. Of course it was ambiguous, unclear, and vague. It then grew to 450 pages as they did clarify the terms, occasions, and methods of purchases.

The third point, along with the call to action, are a request for careful consideration and a warning against haste. The pace at which Congress was pushing the bill last Wednesday was undeniable rushed. A week later, when they were working over the weekend and late into the night, and heard at least three wildly different alternatives on the floor of the House, one might still argue that it's being rushed, but a reasonable person might also consider that an appropriate amount of deliberation and debate, given what's happened in the last week.

So how many of those same economists are against the bill that's actually before Congress tonight? I'm assuming you don't know.

I was against the plan as proposed by Paulson too, but I knew that it was just that, a proposal, and would never in a hundred years make it through Congress untouched. The plan, as it was proposed by Paulson, was brief, vague, heavy-handed, and downright scary. It is not the plan before Congress today.

I'm sure that there are plenty of economists that are still against it, just as there are many economists that are for it, but I would be willing to bet that many of those economists have changed their opinion.

bean said:
Um. Guys, you know this is referring to the 3-page proposal put forth last week by Henry Paulson, not the bill that passed the Senate tonight, and that some of the reasons behind signing the letter are either already outdated or, in hindsight, not exactly correct, right?

A few inattentive malcontents are complaining that I haven't stated my views. I have, but if you want them, or some of them, in one neat place, devoid of subtlety or explanation, here they are:

1. Glass-Steagall repeal was not a major cause of the financial crisis, nor was government-induced "minority lending."

2. We should use regulation to move more of the currently unregulated derivatives markets to the clearinghouse model.

3. The crisis represents a massive conjunction of both market and governmental failure.

4. I would not nationalize banks as ongoing concerns, at least not short of a far more extreme emergency than the current status quo.

5. The modified Paulson plan was better than nothing -- especially after the market had been scared -- but far from my first choice. In any case the plan would have been revised almost immediately. The Paulson and Dodd plans were never that far apart.

6. My first choice is to induce and if need be to force more information revelation, identify the insolvent banks, close them up, and give the battle-tested FDIC a much greater role in the whole process.

7. In the meantime the Fed should not worry much about inflation.

8. The critical deregulatory mistake was allowing excess leverage. Many deregulations get blamed but in fact contributed little to the problem.

9. Everyone says that letting Lehman die was a big mistake but I'm not yet convinced. Maybe a bracingly high TED spread is what we need.

10. Libertarians are overrating the moral hazard argument, as many equity holders have been wiped out.

11. If someone is pushing conclusions and not identifying the potential weak points in his or her arguments, be suspicious. Also beware of anyone pretending to offer you simple answers.

12. I have a long and complicated view on the relevance of Austrian Business Cycle Theory which resists easy summation, but markets could have and should have been more cautious in response to Greenspan's easy money policies.

13. Insolvent hedge funds and the commercial paper market remain outstanding issues which are not easy to address.

14. I agree with Arnold Kling about relaxing capital requirements though at this point I don't expect it to help much.

15. The crisis is complex and has many causes; there won't be a simple or quick solution.

TheFuckOffKid said:
Tyler Cowen of GMU and the Marginal Revolution blog did not sign the letter as far as I can see, but his colleague and co-blogger Alex Tabarrok did.

Here's what Cowen has to say.

Tabarrok comments that his views are similar to Cowen's.

bean said:

I love how you answered your own question there, as though I wouldn't have an answer. That's cute. See, the problem is, unlike the question I asked you where I assumed a response knowing you couldn't possibly have one, your question has a quantifiable answer, and you are wrong.

Testimony of CBO Director Peter Orszag before the House Financial Services Committee (House FSC - 9/25)

petepolly said:

This guy is on the government payroll, the Secretary of the Treasury is backing the proposal. Do you honestly think he is going to tell congress that the proposal is a rip-off even if it is?

Uncognitive said:
Wow, economists from the University of Chicago dislike a plan that increases government intervention in the economy?

I'm shocked. Really.

SignalNoise said:
Hah! I think the entire department from my university signed it...

FearTheReaper said:
Yawn.

petepolly said:

What the fuck is your malfunction?

TheFuckOffKid said:

My understanding is that they were the ones who got the letter going.

That said, it's been signed by many other reputable people, for pretty good reasons.

That said, as bean notes, it's about a previous version of the Bill that a lot of other people had also criticised.

Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

Actions by the Secretary pursuant to the authority of this act shall be subject to chapter 7 of title 5, United States Code, including that such final actions shall be held unlawful and set aside if found to be arbitrary, capricious, an abuse of discretion, or not in accordance with law.

FearTheReaper said:

My doohicky won't go in the thingamajig.

A Curious Coalition Opposed Bailout Bill

By DAVID M. HERSZENHORN
Published: October 2, 2008

WASHINGTON %u2014 Senators who voted against the $700 billion financial rescue plan make up one of the most curious coalitions of lawmakers ever to share common ground.

It included arch-conservative Republicans like Jim DeMint of South Carolina, liberal Democrats like Russ Feingold of Wisconsin and Bernard Sanders, independent of Vermont, who is regarded as the Senate's resident socialist.

Taken together, the speeches of the 25 senators who voted against the plan on Wednesday amount to the Congressional equivalent of a dissenting opinion by the Supreme Court %u2014 impassioned, well reasoned, carefully articulated views on a landmark question of public policy that ultimately reflected the position of a minority of their fellow arbiters. If the bailout plan flops, they are the lawmakers who will be positioned to engage in a chorus of "I told you sos."

Their concerns spanned a panorama of issues: frustration over the lack of long-term regulatory changes in the legislation; alarm that $700 billion in taxpayer money would be at risk; anger that the Treasury secretary would not be subject to more stringent oversight; skepticism that executives of firms that seek help would face limits on their pay; and dismay that such an important bill was being rushed through Congress.

And, perhaps most pointedly, they expressed skepticism that the bailout proposal would be able to restore liquidity to the credit markets, prevent the collapse of additional banks and safeguard the economy from a long recession.

"This package is just a very costly Band-Aid for big banks that will do very little to help patients who need major surgery," Senator Michael B. Enzi, Republican of Wyoming, said in his speech on the Senate floor.

"Had Congress been able to use the regular committee process to craft a bipartisan and comprehensive legislation, the resulting bill may have gained my support," Mr. Enzi said. "Unfortunately, Congress has been pressured into passing this bill in two weeks by Treasury and Wall Street. A rescue plan of this scale requires a clear plan of action with a substantial chance of success. This plan has neither."

Some of the harshest criticism was leveled by Senator Richard C. Shelby of Alabama, the senior Republican on the Senate banking committee, who normally would have been his party's lead negotiator on the bailout bill but removed himself because he opposed the administration's proposal at its very core.

"The choice we faced was between pursuing an informed response or panic," Mr. Shelby said. "Unfortunately, we chose panic and are now about to spend $700 billion on something we have not examined closely. Yes, in the end, we will have 'done something.' At the same time, however, we will have done nothing to determine whether it will accomplish anything at all."

Mr. Shelby, in his speech, laid out a modern history of the American housing, mortgage and securitization markets, explaining how a bubble in home values was fueled by loose lending standards, exotic mortgage products and complex financial instruments, pushed by financial firms that were leveraged heavily to maximize profits.

And in many ways, he was already dishing out "I told you sos."

"We did not get to where we are today by accident, it was a path we chose," he said. "My warnings about the risk of basing credit decisions on well-intended social mandates rather than sound, fact-based underwriting were dismissed. My concerns about the inadequacy of the regulatory structure put in place in the financial modernization legislation went unacknowledged. My efforts to ensure that bank capital standards were designed to ensure safety and soundness, rather than industry concerns, were conducted largely alone."

Mr. Sanders, the Vermont independent, complained that the bill did not put any limits on the types of distressed debt the Treasury could buy, that it did not provide enough oversight, that it did not include adequate provisions to limit home foreclosures, that it did not really limit executive pay at firms that seek help.

"Under this bill, the C.E.O.'s and the Wall Street insiders will still, with a little bit of imagination, continue to make out like bandits," Mr. Sanders said.

He said the bill also did not do anything to prevent financial institutions from becoming "too big to fail," effectively leaving open the potential need for future bailouts.

Mr. Sanders also said he could not fathom giving Treasury Secretary Henry M. Paulson Jr. such broad authority over so much money.

"Maybe I am the only person in America who thinks so, but I have a hard time understanding why we are giving $700 billion to the secretary of the Treasury, who is the former C.E.O. of Goldman Sachs, which, along with other financial institutions, actually got us into this problem," he said. "Maybe I am the only person in America who thinks that is a little bit weird, but that is what I think."

He added: "This bill does not address the major economic crises we face %u2014 growing unemployment, low wages and the need to create decent-paying jobs, rebuilding our infrastructure and moving us to energy efficiency and sustainable energy."

In one of the more remarkable colloquies of the day's discourse, Senator Jeff Sessions, Republican of Alabama, and one of the most conservative members of Congress, took to the floor to express solidarity with Mr. Sanders.

"I would like to say to Senator Sanders a couple things," Mr. Sessions said. "First, I think it is indeed breathtaking that this Senate would authorize basically one person with very little real oversight, a Wall Street maven himself, and allocate $700 billion in America's wealth, which I would have to say would be the largest single authorization of expenditure in the history of the Republic."

Mr. Sessions added: "So I have to say, fundamentally, I think we have not done a good enough job in creating an oversight mechanism that will work, so I am not going to vote for the bill; I am not."

Senator Bill Nelson, Democrat of Florida, said he opposed the bill because it did not do enough to help average Americans.

"This bill sends a message to Wall Street that if they play fast and loose in the name of short-term profits, the government will actually make up for their losses," Mr. Nelson said. "And the bill does very little to help individual homeowners. Until we stabilize the housing market, which is the underlying ability to restructure the economy from this crisis %u2014 until we stabilize the housing market, and until we stem the record number of foreclosures, our market simply is not going to improve."

Mr. Nelson continued: "The bottom line is, ultimately, this bill forces taxpayers to bail out investment banks that caused the crisis in the first place, and it does nothing to address the real problem, which is home foreclosures."

Adroitbeing said:
Clearly our dear friend petepolly has absolutely nothing invested in the outcome - except his tired devotion to libertarian principle.

If petepolly ran a business, he would be concerned about access to capital. He doesn't.

If petepolly had any meaningful deposits held in a mutual fund, where 25% of the value was wiped out in a single day, he would be concerned about shoring up confidence. He doesn't.

If petepolly had any role in sourcing funds for start ups in emerging technologies, some of which he espouses to support, he would be concerned that capital is too scarce. He doesn't.

If petepolly had any responsibility for the employment of 150,000 people in the greater New York area he would be concerned about those jobs and the effect of their loss will have on that economy. He doesn't.

If petepolly were responsible for a payroll, or for bringing new products to market, or for solving any serious business issue, he would be concerned about the lack of confidence and momentum in the market. He doesn't.

If petepolly were thinking about how he might put his child through college, he would be concerned about access to affordable loans. He doesn't

If petepolly felt any responsibility toward rebuilding and expanding the infrastructure of this country; improving roads and bridges, building new water treatment facilities, or improving the electricity grid, he would be worried about bond ratings and the market uptake of municipal bonds. He doesn't.

No, petepolly is simply a libertarian fanboy with a deep fascination for posting excerpts from Atlas Shrugged and quoting standard libertarian phlegm on an Internet chat board, which only helps to make it clear what responsibilities he actually believes are important.