In this week’s edition of The Sunday Paper (the “Cash Crisis” issue), we explore the Wall Street debacle. We also talk with finance experts Alexander Barinov at the University of Georgia and Ivo Welch at Brown University about the economic plans of Republican presidential candidate John McCain and his opponent, Democrat Barack Obama. Here's what they told us about the proposed $700 billion Wall Street bailout:
Q: Senate Democrats are seeking to tack bailout provisions for homeowners in danger of foreclosure onto the $700 billion Wall Street bailout. Is this a good idea? Is the $700 billion bailout a good idea? Aren’t we “nationalizing the financial industry”?
Barinov: Both are bad ideas. Nationwide, it pushes money from one pocket to the other, and gives people an idea that they can behave irresponsibly in the future, because the government will bail them out anyway. Bailout for some major market-making banks may be good (Freddie Mac and Fannie Mae buyout can be good at the end, for example), because it’ll preclude “domino effects”. But the necessary condition of its being good is that the government buys the market-making banks as a whole, with little to no money to the stockholders, and commits to making them private again after the crisis passes. Buying only bad assets is clearly a bad idea. They are illiquid precisely because currently no one, including the government, can price them right.
Bailout for homeowners is just another way of taking money from the rich and giving it to the poor. It does not have any additional benefits, as the buyout of FM&FM and major banks probably does. One can argue about how much of income redistribution is necessary, but it is not clear what makes the (in-danger-of-foreclosure) homeowners so special that they should get extra money ahead of everyone else (e.g., the disabled, people living below the poverty level, etc.)
Welch: All in all, Treasury Secretary Paulson and Federal Reserve Chief Bernanke seem to be doing a good job. Some congressional oversight is not a bad idea, either. In sum, these issues require tough judgment. Restoring confidence in the financial markets is paramount. I am not sure it requires $700 billion, but it may. Paulson/Bernanke are also good in their intent to take large equity stakes in exchange for rescues. Rescuing should be punitive for shareholders and executives, and painless for customers and potential customers.
Q: Shouldn’t someone be talking about the deficit? Or is it too late for that?
Barinov: It’s not burning as long as the world continues to lend us money. But yes, we’ll be the ones who will eventually pay for all the spending the government is making.
Welch: The current deficit is bad, but what is coming with the retirement of the baby boomers will be far worse.
Q: New York Times columnist Roger Cohen has said that AIG was rescued at the behest of foreign banks. “Now foreign banks with U.S. affiliates will want a slice of the $700 billion bailout. That doesn’t make sense until the burden of this rescue starts reflecting a globalized world.”
Barinov: Bailout should be only for huge market-making banks. I don’t think there are US affiliates of foreign banks among them.
Welch: We should coordinate with our foreign government friends to rescue the financial sector. Yes, it makes sense to take care of the entire global financial system. No, it makes no sense for the U.S. to do most of it.
Q: If the financial power of America lies in its huge consumer market, and we have to pay more taxes (to finance the bailout), or even just higher credit card rates, then the power of our huge consumer market is whittled down. Isn’t it?
Barinov: The financial power of America is also in the trust the world places with us. We are the only country in the world that has most of its debt in home currency (which means we can always pay everyone by printing more money and essentially ripping them off, but everyone trust we will never do it). We have to make sure our financial markets remain attractive and keep working well, because otherwise we may have to pay deficit by paying higher taxes in the closest future. Of course, money should be spent wisely, with the aim of helping the free market during the difficult time, not replacing it with government or creating bad incentives by letting people know that they can get all the gains and take no losses, because government will always take the losses on itself.
Welch: Indeed. Ultimately, the US taxpayer will indeed have to foot the bill. Of course, it will be worst for high-income earners (which are not necessarily the wealthy).