FairEconomist_IHB
New member
The Bush administration, through Hank Paulson, has just proposed a massive bailout of the financial industry. The proposal is blatantly unjust, since the taxpayers do not get value for the money. The proposal also incites massive corruption, by combining massive opportunities for insider dealing and favoritism with blanket immunity from criminal prosecution or regulatory review. Many are suggesting similar proposals with these outrageous faults fixed, notably Senator Chris Dodd. This misses the point however, because the fundamental mechanism of the Paulson plan does not address our economic problems. Adding fairness and honest dealing to the fatally flawed Paulson plan still leaves a dysfunctional $700,000,000,000 waste of money.
To understand why, consider how massive bubbles, such as the one we have been through, harm the economy. In a bubble, asset prices become inflated, often to crazy levels. This is a problem because prices are the signals we use to decide what we do and when. As the prices fail to reflect reality, our actions based on those prices become increasingly erroneous. We make mistakes, damaging or failing to protect what we hold dear.
An example might be a family owning a house during the recent real estate bubble. As the price increases, the family believes (incorrectly) it is wealthier. They choose to take out loans against their house so they can enjoy part of their wealth now. This would be perfectly rational if they were wealthier ? a wealthy family shouldn?t scrimp and save now for frivolous luxury later. But, in actuality, the wealth is an illusion, and now that prices are returning to reality, the family has chosen to scrimp and save in the future (to pay off their debt) for frivolous luxury now. They wouldn?t have chosen this had they known the real situation, but the misleading house price has led them to a bad decision.
In some cases such a family may default. This will reduce their loss, but by shifting it onto the lenders. Society is no better off. Arguably, society is worse off, because most call the transfer of wealth bad even though it?s not easily described that way with utilitarian economics (this is a limitation of utilitarian economics).
Homebuilders also have also been led astray by the bogus prices. Seeing profit, they have built vast McMansion farms and giant condo towers. But the prices were wrong, and by the real prices emerging the work and goods used to build them are worth more than the housing. The economy as a whole is worse off from the massive waste.
As long as the prices are bubbly, the decisions are bad and harm accumulates. So in an asset bubble the first goal of public policy is to get prices to a accurate level. Kind of ?Do No Harm?, an economic analogue to the Hippocratic oath.
The fundamental problem with the Paulson plan is that it works by propping up the value of mortgage securities. By buying them above a market price, it transfers money to the security owners. But just as house prices guide families? actions, security prices guide financial firms? actions. Like our family, other firms, seeing the prices of their securities increase, will act on the assumption they have money they don?t and consequently make deals or loans bad for them and the economy. Like our homebuilder, other firms will use the prices as indicators to make more, incorrect, construction deals, and more wasteful construction will drain our wealth.
This, then, is the problem with these bailout plans. Not only do they fail to help the underlying problem, they make it worse. If we must spend $2,000 for every man, woman, and child in America, let?s at least help the underlying problem, not worsen it.
No on the bailout.
To understand why, consider how massive bubbles, such as the one we have been through, harm the economy. In a bubble, asset prices become inflated, often to crazy levels. This is a problem because prices are the signals we use to decide what we do and when. As the prices fail to reflect reality, our actions based on those prices become increasingly erroneous. We make mistakes, damaging or failing to protect what we hold dear.
An example might be a family owning a house during the recent real estate bubble. As the price increases, the family believes (incorrectly) it is wealthier. They choose to take out loans against their house so they can enjoy part of their wealth now. This would be perfectly rational if they were wealthier ? a wealthy family shouldn?t scrimp and save now for frivolous luxury later. But, in actuality, the wealth is an illusion, and now that prices are returning to reality, the family has chosen to scrimp and save in the future (to pay off their debt) for frivolous luxury now. They wouldn?t have chosen this had they known the real situation, but the misleading house price has led them to a bad decision.
In some cases such a family may default. This will reduce their loss, but by shifting it onto the lenders. Society is no better off. Arguably, society is worse off, because most call the transfer of wealth bad even though it?s not easily described that way with utilitarian economics (this is a limitation of utilitarian economics).
Homebuilders also have also been led astray by the bogus prices. Seeing profit, they have built vast McMansion farms and giant condo towers. But the prices were wrong, and by the real prices emerging the work and goods used to build them are worth more than the housing. The economy as a whole is worse off from the massive waste.
As long as the prices are bubbly, the decisions are bad and harm accumulates. So in an asset bubble the first goal of public policy is to get prices to a accurate level. Kind of ?Do No Harm?, an economic analogue to the Hippocratic oath.
The fundamental problem with the Paulson plan is that it works by propping up the value of mortgage securities. By buying them above a market price, it transfers money to the security owners. But just as house prices guide families? actions, security prices guide financial firms? actions. Like our family, other firms, seeing the prices of their securities increase, will act on the assumption they have money they don?t and consequently make deals or loans bad for them and the economy. Like our homebuilder, other firms will use the prices as indicators to make more, incorrect, construction deals, and more wasteful construction will drain our wealth.
This, then, is the problem with these bailout plans. Not only do they fail to help the underlying problem, they make it worse. If we must spend $2,000 for every man, woman, and child in America, let?s at least help the underlying problem, not worsen it.
No on the bailout.
