Government Bailout: We Are All Keynesians Now

In order to resolve the current financial crisis, the government announced an $800B rescue package. Although it was announced on September 18, I believe that Secretary Paulson arrived at this conclusion on the same weekend that Bank of America (BAC) announced its purchase of Merrill Lynch (MER). This makes sense because to commit $50B in such turbulent times, BAC CEO Ken Lewis must have known something that others did not.

Now that the government has proposed the package on the floor, the Democratic- dominated Congress is having second thoughts. CNN has reported that a lot of taxpayers are against this deal and want the financial institutions to reap what they sow. Although this sounds just, the cost of justice will be huge. Think of it this way - you have been let down by both political parties but still you can't just wish them away. Similarly, these financial institutions are necessary.

Coming from socialist India where banks were nationalized, I can tell you it was a great achievement, and in some circles, it was a status symbol to be able to open a bank account. This will give you the idea how hard it would have been to take loans. Just think how easy it was to take out loans for houses, cars and education. The problem started when it became too easy to take out loans. Despite all its flaws, Wall Street has done an efficient job of capital allocation. In addition, if these financial institutions are no more, our financial situation will be a bit like political situation in Somalia.

In this crisis situation, government must act boldly and it has to act quickly. Today is the day that comes a few times in a century when we are compelled to say, "We are all Keynesians now."

Comments

[jacosa:]

I'm sure a Keynesian, and my SEVERE problem with what I've heard about the proposal on the table is that it seems to neglect velocity of money issues. Buying bad assets will eventually free up credit, but it doesn't look rapid. Something closer to the consumer might rescue Christmas retailing and turn over more times in the immediate future.

2008 Sep 23 10:05 AM

[Smarty_Pants:]

The populace of Zimbabwe was also forced to become Keynesian too. Look where it got them. They just dropped 10 zeros from their currency and the economy almost collapsed because they couldn't get enough paper and ink to print currency fast enough to keep up with the need for larger denomination bills.

Keynesian thought runs along the lines that as long as you keep people spending that things will be fine. Problem is when you start printing endless amounts of the stuff they spend. The medium of exchange's value eventually approaches zero and no seller is willing to accept it unless forced to do so.

You can't build an exchange based economy based on a valueless medium of exchange. It won't work forever. Sadly, the US has just about reached the point where the wheels come off under this type of system. Not only are people going to start questioning whether it's a good idea to hold dollars, they're doing so at a point where we're buried in debt that has no meaningful way of being repaid.

This will require some serious pain to unwind. Passing legislation to reward the people who have been driving the bus toward the cliff because they threaten not to stop won't make the huge piles of debt-based losses go away. It just transfers the pain to the public in general instead of those who deserve to suffer.

Let them fail. We'll be better off in the long run. Maybe people will think twice about living beyond their means afterward and society can rebuild itself on a stable, savings-based foundation again.

2008 Sep 23 10:40 AM

[OldDog:]

"Despite all its flaws, Wall Street has done an efficient job of capital allocation." Quite a statement. So efficient that we (the Taxpayers) are about to be buried by a $700 billion bail-out.

I think Wall Street acted as thieves. They created loans that required no documentation, evidence of employment or downpayment. In some cases home buyers were taking cash out at closing, so in essence they were being paid to buy the home! Wall Street bundled these "Mortgages" together and sold them as AAA rated! That's criminal.

We should not bail out the thieves.

2008 Sep 23 11:06 AM

[citetez:]

The true problem in the credit crunch seems to be the accounting rule requiring mark to market. By making people write down assets because there is a temporary market lock up is ridiculous. Any asset priced a s if it must be sold tomorrow rather than in an orderly fashion (hold to maturity value discounted for market interest expectaions) causes the stated "value" to crater. Once the process starts, it snowballs. CDOs and similar products can not be valued because the market dried up. There is no market because everyoe is afraid of what the "mark to market" requirement will do to their balance sheets. If we get rid of the "mark to market" rule, the market will return, and stabiltiy will come back to the financial markets. Such an approach avoids the need to have the government create and finance a market.

2008 Sep 23 11:16 PM

[Econ 101:]

The real thieves are in congress. Has anyone thought about how illegal immigration has added to this problem? The city of Stockton, CA has the highest forclosure rate in the country. The population of Stockton is mainly latino, many of then illegal. Congress encouraged lending to Latino's to promote racial equality.

It isnt the Latino's that are to blame, but the congress who repealed Glass-Segal allowing wall street to go from a max of 12 to 1 leverage to unlimited leverage. Congress who pushed lending to anyone with a pulse, especially any monority. This encouraged fraud, provided big profits to wall street, big political contributions to congress and screwed main street.

2008 Sep 24 12:29 PM