Later On

A blog written for those whose interests more or less match mine.

Do we even need a bailout?

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Interesting question, eh? Kevin Hall explains:

A funny thing happened in the drafting of the largest-ever U.S. government intervention in the financial system. Lawmakers of all stripes mostly fell in line, but many of the nation’s brightest economic minds are warning that the Wall Street bailout’s a dangerous rush job.

President Bush and his Treasury secretary, former Goldman Sachs chief executive Henry Paulson, have warned of imminent economic collapse and another Great Depression if their rescue plan isn’t passed immediately.

Is that true?

“It’s more hype than real risk,” said James K. Galbraith, a University of Texas economist and son of the late economic historian John Kenneth Galbraith. “A nasty recession is possible, but the bailout will not cure that. So it’s mainly relevant to the financial industry.”

The Paulson plan will get some bad assets off the balance sheets of troubled Wall Street institutions and commercial banks. That may help thaw the lending freeze.

But it wouldn’t reduce the crush of homes in or near foreclosure, said Simon Johnson, a professor at the Massachusetts Institute of Technology. That’s a problem that will surely grow worse if the U.S. economy enters recession, leading to greater job losses, which feed a vicious downward spiral of even more foreclosures and defaults on car loans and credit-card debt.

Americans are spooked by talk that financial Armageddon awaits.

The global financial system nearly melted down last week when investors pulled out en masse from money market funds and the short-term debt markets that help corporate America fund its day-to-day needs.

These traditionally have been viewed as safe investments for ordinary Americans, so the flight from them struck fear in the hearts of policymakers.

Few economists, including Galbraith, are willing to discount completely the chance of a financial collapse, given the turmoil in credit markets and banking.

“My sense is it will delay a disaster, given that you only have three months left in this administration. But it will not cure the problem in the (financial) industry or prevent the shakeout and downsizing of the industry,” Galbraith said.

Many lawmakers also expressed skepticism.

Coming out of the White House on Thursday, the ranking Republican on the Senate Banking Committee, Alabama’s Richard Shelby, held up what he said was a five-page list of economists opposing the rescue plan.

“This is not me. This is economists at Harvard, Yale, MIT, University of Chicago, our leading universities,” an exasperated Shelby told reporters. He called the administration plan “flawed from the beginning.”

Johnson, a former assistant director of research for the International Monetary Fund, said: “I think the main problem is what they have on the table is not truly comprehensive, and I think it’s probably not decisive for that reason.”

With the problems in money market funds and the fact that banks have stopped lending to each other except at high rates, the global financial system is as weak as it has been in modern times, he said.

“It’s a very dangerous situation. I would not recommend doing nothing. The world financial markets were in cardiac arrest last week,” Johnson said.

What Congress and the administration failed to do, Johnson said, is develop a mechanism to quickly modify distressed mortgages and prevent even more empty homes from being dumped into real-estate markets in freefall. The plan also doesn’t help banks bring in new capital to boost lending; instead many are sitting defensively on their reserves to offset expected loan defaults.

“I think the rush that happened this week is unfortunate,” Johnson said. “I don’t think it is enough.”

Another doubter of the Great Depression theme is Kenneth Rogoff, a Harvard University economics professor, who thinks …

Continue reading.

Written by Leisureguy

26 September 2008 at 8:42 am

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