Monday, March 23, 2009

A Tentative, Preliminary Conclusion on Obamanomics: Just Not Socialist (or Populist) Enough

I suppose I really ought to stop acting like I’m doing anything besides just talking out of my ass when I start posting all sorts of stuff on "Obamanomics," but still, now that Treasury Secretary Geithner's bank rescue plan has begun its roll-out, both officially and’s what I think.

Obama's big stimulus package--the $800 billion American Recovery and Reinvestment Act--was, in a way, a less broad, more more technical question for debate. Broadly speaking it was, of course, a whole-heartedly Keynesian/progressive liberal approach to the recession: it assumed that government spending can generate (and, perhaps, spread around more equitably) consumer and investor demand, which in turn will drive up prices and increase returns, in turn putting more money in the hands of those who want to sell things and build things, in turn leading to more job creation and more income in more pockets overall. There are all sorts of ways in which the Keynesian particulars of the bill could have been (and, to a degree, were) criticized—-was the money going to this or that project really going to stimulate demand? build more bridges? employ more people? etc.—-but overall, despite the muttering of almost every Republican in Congress, very few people were willing to come right out and denounce the Keynesian approach in principle. They could throw insults at it from the peanut gallery, and place their no votes and write their letters to the editor talking about "socialism," but when you get down to doing something about our, for better or worse, actually existing national economy, pretty much everyone is in agreement that Keynesian economic theory works (or, at least, can and often does do what it purports to do). So, unless one is prepared to go the Front Porch Republic route--which I often am--that leaves us with just arguing over details, with the big picture having already been more or less accepted.

The bank plan is a different matter. Here, you have a massive slab of complete unknowns to deal with, most of which boil down to one thing: these "toxic assets" (or "legacy assets" as Geithner is now calling them) which our major financial institutions have very nearly bankrupted themselves over—-are they essentially worthless, or are they (again, as Geithner is now putting it) of an "uncertain or depressed" value? All those mortgages on all those homes bought by all those people…can they ever really be refinanced and sold? Will those homes ever really be worth more than the land they are built on, at that? This is the unknowable, because when you’re talking about finance capitalism, you’re talking about guesswork and credit and risk. That's what it seems to mean to me, anyway: the aim of the banks is to make those pieces of paper they hold, representing a calculation based upon much more than just the cost of the land the homes are built on and the price of the lumber and the copper wire which holds those homes together, be worth something comparable to what they thought they’d be worth when they bought them (or bought a bundle of them from someone else who had bought them even earlier) to some other buyer or investor. How can they do that?

Two options for dealing with the unknowables of a complex, national market: give professional investors enough money so they feel confident in taking the risk, or let government assume the risk (and the rewards). The Geithner plan does the former, which has lead to anguish and teeth-gnashing amongst the more "socialist" (or better, populist) elements of the commentariat. Geithner and Obama are asking for relatively little buy-in from actual investors (about 15% of the total estimated cost of whatever it is they may or may not end up buying) and with the balance made up of non-recourse loans from the government. Here's how Geitner puts it:

[W]e as a nation must work together to strike the right balance between our need to promote the public trust and using taxpayer money prudently to strengthen the financial system, while also ensuring the trust of those market participants who we need to do their part to get credit flowing to working families and businesses--large and small--across this nation....When financial institutions come to us for direct financial assistance, our government has a responsibility to ensure these funds are deployed to expand the flow of credit to the economy, not to enrich executives or shareholders. These provisions need to be designed and applied in a way that does not deter the participation by the private sector in generally available programs to stabilize the housing markets, jump-start the credit markets, and rid banks of legacy assets. We cannot solve this crisis without making it possible for investors to take risks. While this crisis was caused by banks taking too much risk, the danger now is that they will take too little. [Emphases added]

Geithner is committed to the belief that "we still have a diverse and resilient financial system"; while there are elements of the plan which give the government--and hence, theoretically, us citizens--some oversight and interest in what happens once the loans are made, basically, the current bank plan assumes that the market really will find a good price for these "legacy assets," and that therefore the banks really won’t have to default on these loads.

Here's what Paul Krugman has to say about that (here and here):

[T]he plan proposes to create funds in which private investors put in a small amount of their own money, and in return get large, non-recourse loans from the taxpayer, with which to buy bad--I mean misunderstood--assets. This is supposed to lead to fair prices because the funds will engage in competitive bidding. But it's immediately obvious, if you think about it, that these funds will have skewed incentives. In effect, Treasury will be creating--deliberately!--the functional equivalent of Texas S&Ls in the 1980s: financial operations with very little capital but lots of government-guaranteed liabilities. For the private investors, this is an open invitation to play heads I win, tails the taxpayers lose. So sure, these investors will be ready to pay high prices for toxic waste. After all, the stuff might be worth something; and if it isn't, that’s someone else’s problem. Or to put it another way, Treasury has decided that what we have is nothing but a confidence problem, which it proposes to cure by creating massive moral hazard....

[Defenders of the plan say that] the prospect that assets purchased by public-private partnership will fall enough in value to wipe out the equity as unlikely. But it isn't: the whole point about toxic waste is that nobody knows what it’s worth, so it’s highly likely that it will turn out to be worth 15 percent less than the purchase price. You might say that we know that the stuff is undervalued; actually, I don’t think we know that....So default on those non-recourse loans is a substantial possibility, which means that there is a large implicit subsidy involved....If getting the prices of toxic assets "right" isn't enough to rescue the banks, that...means that we actually have to, you know, rescue the banks, Swedish style, rather than rely on fancy financial engineering to make the problem go away.

And so, for people who are giving themselves crash courses on economics these days, like myself, it really comes down to this to a bit how high concept guesswork: do we agree with the administration that the current credit crisis, like the national economy generally, just needs a bit of Keynesian priming to get to the normal processes of finance capitalism working again? Or do you believe that finance capitalism really has gotten the banks of the U.S. (and much of the world!) into a situation where they are deeply invested in something fundamentally worthless (or, shall we say, unsound), in which case no amount priming is going to prevent the government from having to rescue the banks in the end anyway? I know which way I'm leaning. How about you?


Roberto said...

We are all, to paraphrase Richard M. Nixon, Swedes now -- the sooner we realize it, the better off we will be.

Nationalize the stupid things already! The piety towards The Market is increasingly looking like a cargo cult, only less rational.

Anonymous said...

Last I checked this guy was one of the top ten economic bloggers.

Anonymous said...