By Arnold Kling
The government’s plan to buy equity in financial institutions, announced Friday by Treasury Secretary Henry Paulson, is an idea that many academic economists have championed from the start of the crisis.
The Paulson plan was so bad that just about anything is better. But I’m ready to rip into academic economists. I’ve been thinking more about Joe Stiglitz’s valid criticisms of what I call the Lost Generation of macroeconomists, and I’m getting more and more steamed. If you stacked up everything written by the leading macro folks of my generation and later (actually, starting a few years earlier also), you would have nothing but an enormous baloney sandwich. Ordinarily, I don’t dwell on the fact that these people who were no smarter than me back-scratched each other into the best journals, the prestigious professorships, the important conferences, etc. But sometimes, especially now, I think about how badly they have failed intellectually. They are the precise academic equivalent of Wall Street executives who enjoyed golden parachutes while bankrupting their firms.
Is bank recapitalization a good idea? Probably not, if you think that the main problem with the financial sector is that it is bloated. The best way to restore confidence in banks is to identify the ones that are insolvent and shut them down. The FDIC knows how to do this. They should roll up their sleeves and get to work.
Anyone who wants to stop mortgage foreclosures needs to have his head examined. How many of the bad loans are investor loans, where the borrower never occupied the house? 20 percent of them? 50 percent? 70 percent? We know that in the last years of the bubble more than 15 percent of mortgages were for non-owner-occupied (the true figure might actually be higher than reported, because it is common to fraudulently claim that you will be using the home as a residence when you will not). Investor loans default at a much higher rate than regular loans, somewhere between 3 and 10 times as much. If it’s 4 times as much, then already we can be surmise that a majority of bad loans are investor loans. The best thing to do with those is to foreclose ASAP.
My view of the crisis is that every sector of the establishment has been discredited. The financial establishment has been discredited. Government policymakers and regulators have been discredited. And academic economics has been discredited. The fact that we now have all three on the same page about policy going forward is hardly comforting.