The Economy vs. The Financial Sector

From a NY Times op-ed by Casey Mulligan, a professor of economics at the University of Chicago:

"There are two faulty assumptions here. First, saving America’s banks won’t save the economy. And second, the economy doesn’t really need saving. It’s stronger than we think...The non-financial sectors of our economy will not suffer much from even a prolonged banking crisis, because the general economic importance of banks has been highly exaggerated."

Mulligan then states that an important indicator of health in non-financial sectors is marginal product of capital (how much profit each dollar of invested capital produces). Throughout 2007 and 2008, marginal product of capital has been over 10% per year, which is well above the historical average.

Mulligan concludes:

"So, if you are not employed by the financial industry (94 percent of you are not), don’t worry. The current unemployment rate of 6.1 percent is not alarming, and we should reconsider whether it is worth it to spend $700 billion to bring it down to 5.9 percent."

cf. Steven Landsburg's article questioning the primacy of banking institutions in the U.S. economy.

Ownership Stake

The NY Times reports on the possibilities of the Treasury taking an ownership stake in banks in order to free up credit markets. 

Paul Krugman approves, giving credit to Chris Dodd and Gordon Brown. Nobel Prize winner Gary Becker dissents, saying: 

"There are many illustrations of the bad influence on corporate governance exerted by the governments of France, Italy, Russia, and many other countries that own shares in private companies…This and other examples of harmful government interference in the running of companies where they have an equity interest provides a very good lesson for the United States. Avoid taking any equity interest in private companies when buying assets of banks under the bailout bill."

Crisis talk

"When written in Chinese the word crisis is composed of two characters. One represents danger, and the other represents opportunity."

-- John F. Kennedy

Amidst all this crisis talk, all that ever gets thrown about is the "this is the worst financial crisis since the Depression" jazz. The panic, the emergency plans, the dramatization of meltdowns. In other words, the "danger" side.

Why doesn't anyone think about the opportunity? Since we're in such a bad situation now, what's the risk in trying something new instead of turning to the old ways that have been proven wrong? Why not try actually deregulating and letting the market fix itself instead of insisting that there's been too much deregulation (there's been too much regulation, not its opposite)?

Just some food for thought. The glass is not always half empty.


The Federal Reserve cut interest rates a half a point today, in an effort to reverse the increasingly dismal economic trends. The cut was yet another unprecedented Fed action, and another attempt by government to correct this economic downturn. This crisis has divided people in a number of ways (academic vs. financial economists, fundamentalists vs. realists), but in this post, I'd like to examine the more traditional debate between government interventionists and free market advocates.

I've wavered a bit on the bailout bill, because I haven't been able to pinpoint exactly what the bill was trying to do. If it is trying to increase confidence in lending markets in order to avoid bank runs and allow companies to receive short term loans, I understand (although I haven't seen evidence that credit markets are responding well). However,  if the argument is that AIG, Goldman Sachs, etc. are "too big to fail," the bill becomes harder to swallow. A market system must be a profit and loss system, otherwise the market will no longer focus on the consumer. Thomas Sowell, a magnificent economist, likes to say that economics is the study of "and then what?" When Americans allow the government to arbitrarily choose what the market should look like, what have we said about our economic philosophy?

What worries me most about the recent onslaught of government intervention is the lack of clarity about the problem we're trying to solve. Is this just another bubble that should be allowed to run its course, and did government intervention create the bubble in the first place? Does the Fed even know if these toxic assets will appreciate, or could this $700 billion bailout actually cost taxpayers even more? Is deregulation really to blame? Are we finding more flaws with free market principles, or is this crisis a market correction  of a policy-aided bubble and an overextended financial sector?

Undoubtedly, the past weeks have created a panic among most Americans. Government officials have added to the panic (namely, Barney Frank's assertion that "we don't have a choice now of debating whether (the bailout bill) is a good or a bad thing or Bernanke's and Paulson's predictions of imminent economic collapse). 

Amidst a panic, people see (wrongly, I think) government as a benevolent, omniscient entity. 

In the beginning...

For those who might like a general overview on the genesis of the economic crisis:

How it all happened

Whose fault it really is


In Defense of Government Action

Vincent, I think that throughout this crisis a fundamental reality has been consistently overlooked by those against the bailout. One reason that people seem to object to the proposal is on the grounds that it will spell greater government regulation of the financial markets. The fact of the matter is that the financial market is one of the most highly regulated sectors of the economy. The SEC conducts exhaustive reviews of every major investment bank and commercial bank, in addition to brokerage houses and asset management firms on a regular basis.
Other actions taken by government agencies with respect to the financial markets should perhaps be viewed as measures to vivify the economy rather than strict regulation. For example, the increase in the FDIC's deposit guarantee should ensure that bank deposits, especially those of high net worth Americans, remain in American banks. This will function to increase liquidity and should ease some of the pressure on the banking system.
As Europe continues to experience woes related to a discrepancy between the level of interconnectedness of the domestic economies and domestic governments (hitherto, the governments of Germany, Denmark, Sweden and Austria have all taken steps to fully guarantee bank deposits in their countries), we could see increasing pressure on European governments to form emergency funds to absorb distressed assets, a lá US Treasury.

Thoughts on the Bailout...

And so Wall Street's being bailed out.

Now that the government's going to be regulating the economy, free market's going out the window. Nope, no more free market. The system now will be anything but.

Two articles from the Motley Fool (both pretty heated)

Dear Wall Street: We're watching You

6 Thoughts on the Bailout Buzz