Who is a Realist?
By Arnold Kling
I did not care for Paul Romer’s claim that realists support the Paulson plan, while model-addicted fundamentalists oppose it. In my view, there are realistic reasons to oppose the Paulson plan.
First, many “realists” say that we need to boost home prices. But Ed Glaeser argues persuasively that trying to boost home prices is unrealistic. And if home prices have much farther to fall, then the premise that mortgage securities are undervalued is unrealistic.
I do not think it is realistic to say, “Credit markets are seizing up. Therefore, we must support the Paulson plan.” In fact, if credit markets are seizing up, then something like what the Fed is doing today, as discussed by Tyler Cowen and Alex Tabarrok, makes more sense.
The theory that you can fix credit markets by “removing the clog” of mortgage securities is just that–a theory. My guess is that it will not work. I am sure that other things will have to be tried sooner or later–probably sooner. I hope the other moves work. I do not think it is at all realistic to rely on the Paulson plan. Trying to revive the mortgage securities market is not a realistic solution–it is a very unfortunate distraction.