Professors Against the Bailout

, Bethany Stotts, Leave a comment

Politicians opposing the $700 billion bailout, known as the Paulson plan, got support from an academic venue on Thursday, September 25. Senator Richard Shelby (R-Alabama) met before the press that day to explain his opposition to the plan.

“I don’t know if you have this, but I have…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, we’re rushing to judgment, and that we do have stress in our financial markets, but this is not the best way—we ought to get alternatives,’” Senator Shelby told the press, according to a video released by the BBC. “This is not me, this is economists in at Harvard, Yale, MIT, [the] University of Chicago—our leading universities. Five pages. It ought to tell you something,” he said.

On Friday, the Chronicle of Higher Education ran the story with the subtitle, “For once, a petition has an impact.”

“Neither the mission of the new agency nor its oversight are clear,” wrote the five petition-designers, Professors John Cochrane, Anil Kashyap, Bob Shimer, Paola Spienza, and Luigi Zingales, who come from Northwestern University and the University of Chicago. “If taxpayers are to buy illiquid and opaque assets from troubled sellers, the terms, occasions, and methods of such purchases must be crystal clear ahead of time and carefully monitored afterward.”

Professor Zingales argued that a significant deficiency within the Paulson plan is that it would likely cause the government to purchase subprime mortgages at inflated prices. In a column published on the Vox website, which provides “research-based policy analysis and commentary from leading economists,” Zingales wrote that

“If banks and financial institutions find it difficult to recapitalise (ie, issue new equity), it is because the private sector is uncertain about the value of the assets they have in their portfolio and does not want to overpay.

Would the government be better in valuing those assets? No. In a negotiation between a government officials and banker with a bonus at risk, who will have more clout in determining the price?

The Paulson [Resolution Trade Corporation] will buy toxic assets at inflated prices thereby creating a charitable institution that provides welfare to the rich—at the taxpayers’ expense. If this subsidy is large enough, it will succeed in stopping the crisis.

But, again, at what price?”

Zingales estimates the price of the Paulson plan not only at “billions of dollars and in taxpayer money” but a “violation of the fundamentalist capitalist principle that she who reaps the gains also bears the losses.” Unlike the Savings and Loans crisis, the University of Chicago professor argues, the government has no legal mandate to bail out mortgage firms such as AIG because they never bought federal insurance.

The petition writers showed nothing but condemnation for the proposed plan. “If the plan is enacted, its effects will be with us for a generation. For all their recent troubles, America’s dynamic and innovative private capital markets have brought the nation unparalleled prosperity. Fundamentally weakening those markets in order to calm short-run disruptions is desperately short-sighted,” they write.

But the way forward is not necessarily clear, even for these economists, the list of which includes Nobel Laureate James Heckman and represents economists from 40 different universities. Co-drafter Paola Spienza told the Chronicle that there is considerable disagreement on how to solve the economic crisis. “Everyone agreed on the flaws of the administration plan,” she said. “As for the right way to act, there is [sic] a large number of solutions out there.”

Some solutions suggested by the policy community include

– debt forgiveness;
– a moratorium on the capital gains tax; and
– resurrecting the Resolution Trust Corporation (RTC), the entity responsible for liquidating assets during the Savings and Loan crisis.

So far, the RTC plan seems to have considerable sway in Washington, although, as shown by an Associated Press/Knowledge Networks poll, only 30% of Americans support the $700 billion bailout.

George Mason University economics professor, Tyler Cowen, offered his own advice on how to view the bailout during a small meeting in Washington, DC on Wednesday evening. He advised onlookers to not focus on the price tag attached to bailout proposals over the following days, but to examine the underlying institutional structure, the legal precedents, which will emerge out of any deal made in Washington.

He reminded the audience that the $700 billion price tag means “nothing,” but is only the “first trench” for how much the government might have to spend in the end. Conversely, he argued that it is hard to tell how much the plan would cost considering that the government would likely recoup at least some of the money invested, although how much is hard to determine.

However, former President Bill Clinton told CNS news that he believes the bailout could turn a profit. “The proposal as I understand it…is to set up a fund that will provide liquidity to these companies and hopefully enable a workout of individual mortgages…,” he said. “If we do that and we make investment as the government did, like in AIG where they took an 80% ownership share and loaned them money at a fairly high interest rate, I think that—as Barney Frank said yesterday—in the end it won’t wind up costing the country anywhere near $700 billion, and we might actually get all our money back and then some if we manage it right.”

Troy University Professor Christopher T. Warden connected the roots of the housing crisis to the Carter-era Community Reinvestment Act (CRA) during his July 31st lecture at the National Press Club. “The ‘housing crisis,’ you know, greedy bankers, speculators—nobody’s reported that in the 70’s Congress passed the law called the Community Reinvestment Act, which essentially said we’ve got to have more low-income home owners, so we’re gonna wave the credit-worthiness test for these people” he said at the Accuracy in Academia seminar. “Is that a recipe for defaulting? I mean, you don’t have the wherewithal to pay off this loan, but we’re going to give it to you anyway. Never reported.”

Professor Warden is the author of Voodoo Anyone? Economics for Journalists, a textbook which AIA is publishing.

But writers at the Wall Street Journal, Investor’s Business Daily (of which Warden is a former editorial-page editor), the National Review, and many blogs, are now discussing the Community Reinvestment Act and the seminal effects it has had on the housing crisis. Some even blame President Clinton’s 1995 revisions to the CRA, which pushed banks to increase their loans to the subprime market.

Bethany Stotts is a staff writer at Accuracy in Academia.


 

Leave a Reply

(*) Required, Your email will not be published