Tuesday, September 30, 2008

The great unraveling (maybe) - Part 1

As everyone who cares knows by now, the initial vote on the big financial bailout bill failed in the House yesterday. I can't sort out the claims and counterclaims. Were the Republicans who voted against it acting on principle, or pandering to the uninformed electorate? Did they scuttle something which is needed to save the world, or did they give us breathing room to find a better solution? Did Hank Paulson mess it up through inartful political handling, unaided by the inept White House, or is he still our last best hope of staving off financial collapse? Is Nancy Pelosi to blame? Was John McCain more of a help or a hindrance? Did Barack Obama do enough?

I don't know the answers to any of those questions, and I don't find them very interesting for the most part. Since I imagine something will end up happening eventually, lest Congressmen see their stock portfolios drop to 0, and I would guess that the price tag will ultimately be just about the same (we hear about dropping the initial request to $350 billion, with provisions for more to be added later), I really only have two fundamental questions here. My questions are considerably longer-term in nature, and I think they've been overlooked as people run around in crisis mode.

The first essentially comes out of the question that was asked at last week's debate, and that is how government initiatives will be curtailed by whatever funds we commit to this bailout. (By the way, if one of the reasons we're bailing out the banks is to save the world financial structure, shouldn't the world be contributing something to the effort?) Both candidates gave enormously weak answers to this question, but it's fair to ask: If we're paying for this, what will we have to give up?

A couple of days ago, Brad DeLong agreed with Larry Summers on this, in a post titled, "How Much Will This Cost? How Does This Constrain the Policy of an Obama-Biden Administration?" The basic contention is that the answers are "not much" and "not at all" (to quote DeLong). From Summers:
The American experience with financial support programmes is somewhat encouraging. The Chrysler bail-out, President Bill Clinton’s emergency loans to Mexico, and the Depression-era support programmes for housing and financial sectors all ultimately made profits for taxpayers....[The ultimate cost] is very unlikely to approach $700bn and will be spread over a number of years.
(If you're wondering, this article is from the Financial Times, and was obviously edited; I don't think Larry Summers has become British - "authorisation" and "programme," indeed.)

While I certainly see that no one in the government will be writing a $700 billion check tomorrow (or whenever they get passed whatever sum we're going to spend), this strikes me as remarkably rosy predicting. In each of the cases Summers mentions, this money went to aid a fairly narrow set of Americans at a time when that money could only stay in America. The world is different now, and the broad-based "aid" that we're offering to multinational financial corporations, indemnifying them against risk they willingly adopted, seems different from those other plans. We have already seen too many ways in which profits can "leak" out of the system, in this case leaking away from the taxpayers who assumed the risk.

I don't want to say Summers and DeLong are wrong here - they are very respected economic minds - but it concerns me that they can believe that we can count on Washington to make this happen inevitably well. Summers even points that out, while blithely dismissing it:
It is impossible to predict the ultimate cost to the Treasury of the bail-out programme and of the other guarantee commitments that financial authorities have – this will depend primarily on the economy as well as the quality of execution and oversight.
I'm not fully reassured.

To move to the second part of DeLong's question, the one which concerns me, as to how will this limit actions in a new administration, Summers' reasoning is actually a bit chilling:
Indeed, in the current circumstances the case for fiscal stimulus – policy actions that increase short-term deficits – is stronger than at any time in my professional lifetime. Unemployment is now almost certain to increase... to the highest levels observed in a generation. Monetary policy has very little scope.... [E]xperience around the world with economic downturns caused by financial distress suggests that while they are of uncertain depth, they are almost always of long duration.... The more people who are unemployed the more desirable it is that government takes steps to put them back to work by investing in infrastructure, energy or simply through tax cuts that allow families to avoid cutting back on their spending.
Understand what Summers is saying here. He is saying that the situation will be so bad that government will be forced to intervene to keep American families afloat. High unemployment will force Uncle Sam to invest in job creation strategies or cut taxes to allow Americans to continue to spend. Therefore, none of Obama's ideas for helping the economy will need to be curtailed, his priorities will not need to change one whit.

This is where I inevitably find economists unpersuasive. It is well-known that Summers is an adviser to the Obama campaign, and he is often on the short list of those speculated to take a powerful role in a new administration. So his conclusion is not surprising.

It is equally unconvincing. We have a colossal deficit now, and Summers believes that we can add a bailout plan (maybe ultimately profitable, but not for quite a while) and fiscal stimulus on top of that. Leaving aside the moral example of government running a long-term debt machine, who will take the other side of this bet? How much more of our government paper can we expect the Chinese to buy?

I understand the Keynesian argument that, in times of downturn, deficits are desirable. But that belief depends on the idea that the deficit will easily be paid back when times are better. Two things can go wrong with that argument: 1) The deficit might be too big ever to be easily repaid; and 2) Times may never get better enough to allow the repayment.

We've never run into a situation where either 1) or 2) applied before, but this triple storm that Summers and DeLong apparently think benign strikes me as very chancy. A small deficit to permit the country to get back on track and grow, at which point the deficit disappears? Sure, sometimes. But a deficit based on a two-front war and growing entitlements and a bailout of transnational financial institutions and a stimulus package of infrastructure and energy to get people back to work? Ask yourself how much the economy would need to grow to pay all that back in a world in which other countries are eating our lunch.

(By the way, that's assuming that the government expenditures would even fully stimulate the economy. Since modern accepted fact does not allow for direct government job creation, we would have to "stimulate" the economy by promoting private job creation. I have already written several times as to my doubts about the casual assumption that New Energy = New Economy - the manufacture of fan blades will not happen in this country, there's no reason to think so.)

My guess is that this bailout will force a dramatic reprioritization of our government, whoever wins, and we will have to look at another (pick a number) years of no movement on health care, no progress on early childhood education, no sweeping energy policy, and so forth. I'm not saying I support all those things, at least not in the form in which they've been presented, but we're going to spend so much time and energy and money on the financial system that we'll likely make little progress toward any of those objectives.

My second big long-term question is something that I'll have to take up tomorrow.

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