In response to David and Bryan, I do not think that Ben Bernanke and other Fed officials are sitting inside their offices plotting to ruin the economy while saving banks. They have convinced themselves (and most pundits) that saving the banks is saving the economy. They have failed to convince Scott Sumner, and they have failed to convince me, but in the grand scheme of things, that means little.
We will never know whether the bailouts made us better off or worse off. The conventional wisdom is that without the bailouts things would have been much worse, but that is just an incantation not an empirical truth.
I would note, however, that
1. Relative to expectations in the fall of 2008, banks are doing better and the economy is doing worse.
2. If the Fed were focused solely on stimulating the economy with conventional monetary policy, then there would be no need to buy mortgage-backed securities and no reason to pay interest on reserves.
READER COMMENTS
Bob Murphy
Feb 14 2010 at 12:40am
Why are you guys so afraid think that people in Washington might say one thing to the public, while acting on purely self-interested motives? I thought that kind of non-naive analysis was what George Mason was all about:
http://mungowitzend.blogspot.com/2010/02/ezra-klein-asks-for-something-he.html
Elvin
Feb 14 2010 at 1:20am
I think that is has been unwritten and unstated policy that we will recapitalize the banks through profits since Geithner released the stress tests last Spring and declared the banks OK. So, yes the banks are doing better than the economy.
The Fed won’t give up the near zero discount rate policy until both unemployment is significantly lower and the banks have replayed the last of the TARP money and are properly recapitalized.
The steep yield curve allows the banks to pick up near risk free profits. (If any one has data about purchases of Treasury debt by banks, I’d be interested to see it.)
My biggest beef is that the management of banks is largely still in place and the bondholders didn’t get a haircut. We could have just as well recapitalized banks in October 2008 by making debtholders take a 10% to 25% discount, which is the discount that senior bank debt was priced at around that time.
My guess is that receivership by some combination of the Fed, FDIC, and Treasury was too legally messy and didn’t offer a quick resolution. First, who had the authority to do something? The FDIC to some extent did, but only over depository institutions. The Fed probably did have some emergency powers. The Treasury certainly didn’t, which is why it had to go begging to Congress with TARP. Second, where did the claims of swap holders (both credit default and interest rate) stand? Where did the SIVs and conduits stand? (At least with FNMA and FHLMC Congress made it clear that the Treasury could take them over in July 2008, which was a strong signal that they were in trouble.)
I believe that one aspect of financial reform should include a special bankruptcy/receivership role for the Fed and FDIC to take over insolvent institutions and wind them down. Management should be dismissed, equity holders get pennies, debtholders take haircuts, and counter-parties in derivatives take the risk that they could get nothing.
Tom Grey
Feb 15 2010 at 9:08pm
Yes, Elvin! Management should have been dismissed — and instead of TARP to bailout the super-rich Big Bank losers, there should have been special Fed / gov’t ‘fast bankruptcy’ proceedings to strip the equity and management out of the insolvent Big Banks who speculated on CDS & such derivatives.
After the housing bust in 2006, thousands and hundreds of thousands of construction workers and builders lost their jobs — over investment in house construction.
The banking system was also over invested in financial products built on top of securitized assets — they should have followed the builders into bankruptcy.
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