While it seems likely that the Democratic and Republican Congressional leadership will be successful in hammering the Paulson-Bernake bailout bill through Congress this week, there are some people out there making the case against the biggest government intervention in the financial system since World War II.
Casey Mulligan, an economist at the University of Chicago, for example, shows us that, while Wall Street is hurting from the mistakes that have been made over the past decade or more, Main Street is still doing relatively well:
Since World War II, the marginal product of capital after-tax averaged between 7 and 8 percent per year. During 2007 and the first half of 2008 – exactly the time when financial markets had been spooked by oil price spikes and housing price crashes – the marginal product had been over 10 percent per year: far above the historical average. Compare this to the marginal product of capital in 1930-33 (the years of Depression-era bank panics): 0.5 percentage points per year less than the postwar years and significantly less than in 1929. The marginal product of capital was also below average prior to the 1982 recession (in this case, far below average) and prior to the 2001 recession. Thus, the surprise was not that GDP continued to grow 2007-8 despite the bleak outlook from Wall Street’s corner of the world, but that GDP growth failed to be significantly above the average. More important from today’s perspective is that much capital in America continues to be productive, and that this will likely permit Americans to advance their living standards as they have in years past. The non-financial sector today looks nothing like it did in 1930.
The weak correlation between asset prices and non-financial sector performance and the strong profitability of today’s non-financial capital are two good reasons to scoff at the idea that the non-financial sector will collapse because of the recent events on Wall Street, and even better reasons to scoff at the Bernanke-Paulson-Bush idea that a massive bailout of financial firms is the key to avoiding a non-financial collapse.
Following on Mulligan’s point, Dale Franks reminds us that the Fed will have to “create” the $ 700 billion that will fund this plan out of whole cloth, which will have implications of it’s own:
[W]hatever money the Treasury pours into the MBS market is brand spanking new money. It’s no different than if the Fed pumped $700 bil in cash into the economy buy buying 1-year noted from every Federal bank in the country. Such a massive increase in the money supply is wildly inflationary.
That give rise to two problems.
First, we’re intentionally inflating the money supply, which will further crush the dollar in the FOREX markets. It will expose foreign holders of government and commercial paper to increased exchange rate (currency) risk that may very well force them to sell off that paper. If they do, he glut of bond sale will cause bond prices to fall, and yields, i.e., interest rates to rise sharply. It won’t matter if the Fed lowers the Discount Rate to 0% and opens the Fed Funds window as wide as it can go. Sales of commercial and government paper can force interest rates through the roof. The high price of money will stifle credit demand all across the economy, slowing GDP growth substantially.
Second, even if the above wasn’t true, the increase in inflation would inevitably require the Fed to ratchet up interest rates in order to get inflation back under Control. We’d be right back in 1981-82 territory again, which, for those of you who don’t remember, meant 18% mortgage rates, and 11% unemployment.
Franks goes on to note that the bailout doesn’t avoid the pain of more than a decade of bad decisions, but merely transfers it from those responsible for the problem to the public as a whole:
The only question now is who feels the pain. And, as my previous point indicates, the Government is on the verge of spreading that pain around, and we may all feel it sharply.
[S]omeone is going to feel the pain. The only question is who feels it. Right now, it looks like the answer to who feels the pain is, thanks to the government, “All of us.”
And, then, as I noted yesterday, there’s the immense moral hazard problem that this bailout creates.
If homeowners, bankers, mortgage lenders, mortgage brokers, securities traders, and politicians can spend a decade or more making bad financial decisions only to have the government step in at the last minute and save them from the consequences of their actions, then what signal does that send to the next person inclined to take an insane risk ?
Part of capitalism includes the risk of failure, and when people make financial decisions they ought to calculate those risks into their decision making process. When the government stands on the sideline and says that they’ll save you if you fail, it makes it a lot easier to take risks that harm not only yourself, but others as well.
Whatever that is, it’s not capitalism, but it’s what we’ll be left with after this bailout becomes law.