To Bail Out or Not to Bail Out?

As Michael mentioned, the issue of a bailout of financial firms holding so-called "toxic assets" on their books was raised at the Town Hall meeting last night. We discussed both sides of the matter, but failed to reach a definitive conclusion. The Treasury's proposed bailout has been amended from its original version; rather than having the federal government purchase the securities directly from the ailing financial firms as was initially suggested, the Treasury would, in effect, act as an insurer and provide security to private firms that buy the assets.
Our discussion at the meeting centered primarily around the issue of whether or not the Treasury Department should be proposing the package at all. Economists have weighed in on both sides of the issue. A plethora of economic heavyweights have voiced opposition, based on a number of factors. Two primary issues that they have taken with the plan are as follows: 1) the seemingly unwarranted burden that would be placed on the average American through taxes to finance the deal, and 2) the concern over a case of moral hazard being presented to the firms bailed out.
Conversely, the plan has been defended on a number of fronts. A compelling argument in favor of the bailout plan would seem to be the potential danger posed to the greater American economy if such a deal were not enacted. It is constructive to note that many financial institutions as well as other corporations have significant portions of their assets tied up in credit markets, some of which remain frozen. If these firms are not able to gain access to cash, we could very well see a leftward shift in aggregate demand, resulting in inhibited growth and income per capita.

Other thoughts?

Addendum: Insurers in the private sector use statistical analysis to calculate the expected value of a given event occurring, and base premium payments on that calculation in an attempt to make a profit. Although the Treasury is certainly not trying to turn a profit from this deal, I'd be interested to know their calculation of an expected value of the further depreciation of these assets after their transfer.


Patrick said...
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Patrick said...

Good insight, Ted. I'll start this comment with an open invitation for a rebuttal or response, because I am not 100% certain I have this worked out fully.
The only issue I have with the "bail out" is that it is not really a bail out at all. I think a better name would be a rescue plan, or a means of self-correcting. From my understanding, the crux of this problem lays at the feet of the governmental intervention and guiding of Freddie and Fannie back in the Clinton administration. The cause of the credit problems started when President Clinton appointed as heads of these organizations Franklin Raines (incidentally now Barack Obama’s economic policy advisor) and Jim Johnson (also working for the Obama campaign). It was these leaders, using dodgy accounting practices and lending policies, who drove the agencies into the ground. Under the popular guise of providing “affordable housing,” their unsound lending policy laid the groundwork for the problems we’re seeing today. The majority of the mortgages held by firms and banks are okay – it is the 5% or so of the sub-prime ones that are causing this extremely dangerous situation that has spiraled out of control. The reason I am getting into this is that, in essence, this background provides a rational basis upon which a sensible liberal economist can justify this “rescue plan” – an undesirable, yet necessary type of government intervention in the economic sector - to correct what was originally a government mistake.

As Milton Friedman stated, "Most of the energy of political work is devoted to correcting the effects of mismanagement of government." In this case though, the mismanagement might just be so great that the intervention is warranted.


Kevin Walton said...

Pat, first off let me tell you that the irony you pointed out is quite amusing. Secondly, I agree with you. The government intervention is necessary to fix the problem caused by the government. Let's just hope that the government will learn from their past mistakes and not repeat them, just as the banks and financial institutions need to do the same. From the preliminary drafts of the "bail out" plan, though, it looks as if they are at least attempting to avoid this conundrum again.