Sunday, September 21, 2008

Krugman on Why We Should Demand More from Paulson

The Krug sums it up nicely. The problem isn't the current crisis, but how to prevent the "solution" for the current crisis from becoming a huge profit-grabbing boondoggle for Bush's "base":

Thinking the bailout through

What is this bailout supposed to do? Will it actually serve the purpose? What should we be doing instead? Let’s talk.

First, a capsule analysis of the crisis.

1. It all starts with the bursting of the housing bubble. This has led to sharply increased rates of default and foreclosure, which has led to large losses on mortgage-backed securities.
2. The losses in MBS, in turn, have left the financial system undercapitalized — doubly so, because levels of leverage that were previously considered acceptable are no longer OK.
3. The financial system, in its efforts to deleverage, is contracting credit, placing everyone who depends on credit under strain.
4. There’s also, to some extent, a vicious circle of deleveraging: as financial firms try to contract their balance sheets, they drive down the prices of assets, further reducing capital and forcing more deleveraging.

So where in this process does the Temporary Asset Relief Plan offer any, well, relief? The answer is that it possibly offers some respite in stage 4: the Treasury steps in to buy assets that the financial system is trying to sell, thereby hopefully mitigating the downward spiral of asset prices.

But the more I think about this, the more skeptical I get about the extent to which it’s a solution. Problems:

(a) Although the problem starts with mortgage-backed securities, the range of assets whose prices are being driven down by deleveraging is much broader than MBS. So this only cuts off, at most, part of the vicious circle.
(b) Anyway, the vicious circle aspect is only part of the larger problem, and arguably not the most important part. Even without panic asset selling, the financial system would be seriously undercapitalized, causing a credit crunch — and this plan does nothing to address that.

Or I should say, the plan does nothing to address the lack of capital unless the Treasury overpays for assets. And if that’s the real plan, Congress has every right to balk.

So what should be done? Well, let’s think about how, until Paulson hit the panic button, the private sector was supposed to work this out: financial firms were supposed to recapitalize, bringing in outside investors to bulk up their capital base. That is, the private sector was supposed to cut off the problem at stage 2.

It now appears that isn’t happening, and public intervention is needed. But in that case, shouldn’t the public intervention also be at stage 2 — that is, shouldn’t it take the form of public injections of capital, in return for a stake in the upside?

Let’s not be railroaded into accepting an enormously expensive plan that doesn’t seem to address the real problem.

The problem is that the proposed "solution" is not actually addressing the underlying causes of failure, and it increasingly looks like an attempt to have the taxpayers foot the bills for the financial malfeasance of Wall Street.

Here are more helpful links to keep track of analysis of the issue:

Krugman: Calculated Risk:


1 comment:

Annie said...

The Krug sums it up nicely. The problem isn't the current crisis, but how to prevent the "solution" for the current crisis from becoming a huge profit-grabbing boondoggle for Bush's "base":

That's gonna be tough, because that's what it's all about. Like a virus, Bush and Co are ever evolving. Back in 2003 they had to create a war to get the billions. Now they have now found a way to get a war's profit without a war. Since they have not been able to sink their fangs into social security ( yet) or get a new war ( yet) this bail out will have to do for now . Look for more. Because modern Wall St cannot function without a insider swindle, a snake oil scam ,an obscene bubble....and if when bubble pops, it crushed whole segments of the population, that's even better.

It's about reaming out the United States out like a stolen car and that's all. The Bush administration is not incompetent in least . It's the most accomplished thief the world as ever known.

Another thing to think about is, the press that wanted Bush and the war, now want Obama. Whatever the press wants is bad for 98.999 % of the population.
It's an infallible guide.

Thank you for your posts