By Arnold Kling
Two links from the indispensable Mark Thoma. First, Tyler Cowen writes,
A newbank rescue plan may be more crucial right now than the fiscal stimulus package enacted last month. Yet we don’t seem capable of finding a clear path toward cleaning up our major financial institutions.
…It is quite possible that the reputation of a nationalized bank would be so impaired that it would incur even greater losses as its web of commercial dealings collapsed. These far-reaching commitments are a reason that the F.D.I.C. model of rapid shutdowns cannot be applied so easily here.
Read the whole thing. Tyler thinks we may just have to muddle along, trying to use band-aids and tourniquets. I continue to prefer the approach I suggested from the beginning.
1. Close any bank that is clearly insolvent.
2. If a bank may be solvent but fails to meet rigorous capital standards, then put it under close supervision until the situation resolves. The bank is not allowed to make any new risky loans, but otherwise it can continue to operate. The bank can borrow from the government to cover short-term liquidity needs, but not to expand operations, pay dividends, or compensate executives in cash (it can award them stock or stock options).
3. Leave healthy banks free to operate.
The difference between (1) and (2) is that in (1) the shareholders are wiped out immediately, while in (2) the shareholders have some upside. The difference between (2) and (3) is that with (3) the managers can actively try to increase shareholder value. With (2), the bank is effectively on probation, with shareholders only able to earn a return if it becomes clear that the bank’s toxic assets are not sufficiently bad to take it into insolvency.
Second, David Colander and others write,
In our view, economists, as with all scientists, have an ethical responsibility to communicate the limitations of their models and the potential misuses of their research. Currently, there is no ethical code for professional economic scientists. There should be one.
I count a total of 8 co-authors for the paper–quite unusual in economics. Read the whole thing. One point they make is this: did economists know that the models that financial firms were using were flawed? If we answer “no,” then we were spectacularly incompetent. If we answer “yes,” then we were spectacularly unethical, because we failed to convey these flaws to decisionmakers. Along the latter lines, you will find if you do a search that Paul Volcker thinks that geeks are using the Nuremberg defense in defending their role in the financial crisis.
I don’t think the authors’ recommendations for future research are helpful. They advocate fancy-shmantzy econometrics. They need to read my lost history paper. They also recommend trying to develop ways to anticipate and control bubbles. I think that is like recommending trying to develop world peace. It’s easy to endorse the ends, but you will never agree on the means.