Tuesday, February 10, 2009

Bailout, part 2

Now that Obama seems to finally have to support he needs for the much-needed stimulus, it is worth considering the recently proposed treasury plan by Geither.

The case for the Treasury plan rests on the assumption that without such a plan, banks will not lend money and this will keep the U.S. mired in recession. It is not surprising that many economists have this perspective, in part because financial markets and lending have become the focus of economics over the past 20 years. This is not only because of the shift towards neoclassical economics but also because a lot of economists went on to careers in finance, and also because market data is among the most accessible in the world. Now that the crisis has hit, economists are eying the financial system, and guessing that things will not improve until lending occurs again.

It is certainly true that the economic system of six months ago was heavily reliant on credit and lending, but is the current one? People are hesitant to fund buying with lending, probably for good reason. Even if the banks dangle out interest-free loans to those who can prove their credit-worthiness, I don't see people taking them at the moment. It seems unlikely that many businesses or individuals are going to take on more debt than is worthwhile, given the current conditions.
And will banks lend without a bailout? Certainly some will go bankrupt, but banks with a proper approach to evaluating the riskiness of borrower should continue to lend money at as high a rate as they can.

It wasn't the banks that created this recession, it was a shift in consumer spending and saving as a result of high oil prices and the collapse of the financial system. Although the stimulus can replace some of private demand, a larger one risks realigning the economy towards industries benefiting from the stimulus. The economy will only start to grow again when consumer confidence recovers, but debt-fueled spending is a thing of the past. The goal of the government at the moment should not be recovery, but rather employment and a positive restructuring of the economy.

So I would argue that something like $250 billion should suffice to protect consumers from bank failure. In addition, measures should be put in place to encourage banks to resolve the bad assets on their books (the 'stress test' that is the best part of the current bailout package).

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