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Greg Mankiw defends the Paulson plan (from a distance)
Read the whole thing, which is full of economics. I think the bottom line is this part:
...that's [capital injection] a complement to an asset purchase plan, not a substitute -- and it's one allowed by the Treasury proposal and indeed envisaged in some cases. But that will take much longer to implement than an asset purchase. That's why it's a complement not a substitute -- Treasury needs to act now.
In other words, we are going to get both the Paulson plan and the Dodd plan, or some modified versions thereof. It was never either/or. Note that if Greg's arguments are correct things are very bad indeed. The outstanding open question is why markets don't now, pre-plan, successfully trade the toxic assets in sufficient quantities. But they don't.
Posted by Tyler Cowen on September 25, 2008 at 03:12 PM in Economics | Permalink
Comments
What has struck me about economic commentary, including that here, is how little academic economists actually know about the workings of the capital markets. Also how little law professors know. I'm curious about why there is such a gulf between finance professionals and scholars of the relevant academic disciplines.
Posted by: y81 at Sep 25, 2008 3:18:57 PM
Re: The outstanding open question is why markets don't now, pre-plan, successfully trade the toxic assets in sufficient quantities.
Because there's default swaps in place, no?
Posted by: Scott B at Sep 25, 2008 3:22:04 PM
At ground level in the real estate market, it's because the banks won't take significant enough losses on foreclosed homes. I'm always stopping at open houses on the weekends. Last weekend, I saw a new listing for $390,000. 3BR/2BA small back yard, nice enough to move in. I also saw a foreclosure that had been on the market for 3 months, asking price $439K. 3BR/2.5BA, a real dump, would need $25K to make it livable and who knows about termites, gas, water, etc. I felt bad for the agent baby-sitting that place because it won't sell for more than $350K and the bank isn't interested in selling at that price. When the banks figure out the true value of what they have, it will drag the values of everything else down, creating more problems.
Posted by: BoscoH at Sep 25, 2008 3:24:37 PM
Is this really Mankiw's defense? Or his friend's?
Posted by: Samir Nurmohamed at Sep 25, 2008 3:27:52 PM
Never mind, my blog reader cut off the title...I see now.
Posted by: Samir Nurmohamed at Sep 25, 2008 3:28:43 PM
Could a Wall street economists job be in jeopardy if there is no bailout?
I hardly think it is an unbiased opinion.
I would have liked to have seen solid evidence that backed up the the administrations claims of financial Armageddon.
Posted by: Marc at Sep 25, 2008 3:31:01 PM
One does not need an economics degree to deduce that the federal government created this mess and that a reduction or elimination of federal laws that drove the crisis critical. Further, call it what we may; our federal government will own home mortgages, which will essentially take our constitutional republic even closer to than it already is to socialism. Mind you, most actors in this drama have good intentions and are simply trying to cover their behinds---but to suggest any "profit" will find it's way into debt reduction or, God forbid in the American taxpayers pocket is absurd. The Feds will take the money and expand the role of government.
We should reduce/eliminate the capital gains tax, corporate taxes, and repeal Sarbanes-Oxley---and while we're at it eliminate Fannie and Freddie by putting them on the market. Most of the paper they hold is legit---the paper that is not will be foreclosed.
The government needs to get the hell out of the way---there's plenty of money in the private sector that would rush in if capital gains alone were eliminated/reduced drastically---that would be a start and it would not cost the taxpayer a nickel. Change we can believe in; a smaller, less restrictive federal government.
Posted by: J Scott at Sep 25, 2008 3:31:40 PM
Greg's whole response seems a little silly.
Per the M-M theorem, the execs shouldn't care if there are warrants. In fact, if they resist the warrants, that's basically saying "We know the auction mechanism will be designed badly in a way that will screw the taxpayers".
Posted by: Dan at Sep 25, 2008 3:33:47 PM
Just to clarify my comment above, if the auction was perfectly designed, we wouldn't need the warrants per MM. But it will be badly designed (in my mind with p>.9), so we need the warrants.
Posted by: Dan at Sep 25, 2008 3:35:46 PM
The entire point of warrants or some form of equity stake is to align interests and reduce potentially disastrous (at least optically) outcomes if the toxic securities themselves are incorrectly priced at the outset. This is the central fear being discussed ad nauseam in connection with Treasury's plan. If the Treasury "overpays," at least it will have a chance to recover some of the value transfer in the form of potential appreciation of the warrants in its counterparty. If it underpays, or pays the "right" price--whatever that is--presumably the warrants become valueless and hence moot.
Greg's interlocutor assumes correct pricing as a given, thereby neatly avoiding the entire rub and begging the biggest question on the table. Sloppy, sloppy.
Posted by: The Epicurean Dealmaker at Sep 25, 2008 3:49:21 PM
Oh, and by the way, I hope no-one tries to foist the old canard on us that the current (depressed) market prices of the securities at issue are in fact the "correct" or "fair" prices. (Because, whatever the price, they are set in arms-length transactions ...)
The entire [blank]ing point of TARP is to bridge us over a period in which multiple non-self-correcting market disruptions and breakdowns have in fact severed the connection between market prices and fair value. If you do not believe the market has failed in this way, you can have no reason to suggest we need TARP (or anything like it) in the first place.
QED.
Posted by: The Epicurean Dealmaker at Sep 25, 2008 3:56:51 PM
If we're interested in incentives we might ask why Greg Mankiw would want to support a plan put forward by this administration, even when most economists think it's shocking. A less charitable person than I would say it's because Mankiw has consistently defended as well as being the architect of the policies that got us into this mess. He feels he has to defend his friends.
I would dearly love to read Mankiw's defence of his role in this whole fiasco. Certainly a lot more than his relentless support of the party line.
Posted by: Finnsense at Sep 25, 2008 4:04:27 PM
I for one am getting really tired of economists with no faith in markets. The idea that current "fire sale" prices must be less than the intrinsic worth of the assets is pure conjecture, supported by nothing. This is not economics, its just assertions.
Posted by: Jeff at Sep 25, 2008 4:05:57 PM
More Mankiw obfuscation.....
Mankiw;
...Treasury is committed to get the market price as best as it can....
Bernanke;
....I believe that under the Treasury program, auctions and other mechanisms could be devised that will give the market good information on what the hold-to-maturity price is for a large class of mortgage-related assets. If the Treasury bids for and then buys assets at a price close to the hold-to-maturity price, there will be substantial benefits....
In other words Mankiw claims that the the treasury is going to pay the market price and in the testimony P&B made it clear that they want to pay far more than market. Mankiw knows this but does not want to respond to that criticism.
Posted by: RobbL at Sep 25, 2008 4:17:53 PM
I think Dan and T.E.D. are right about the warrants. Mankiw's argument against them does seem to depend on thenotion that the MBS price will be accurate, but confuison about that price seems to be at the root of much of the trouble. The warrant penalty, it seems to me, will induce security holders to accept lower prices than otherwise, not to demand higher ones.
Posted by: Bernard Yomtov at Sep 25, 2008 4:19:53 PM
Jeff @4:05:57 -- If that was aimed at me, you missed. I am not an economist, I am a market practitioner who normally has a great deal of "faith in the markets." In fact, most market practitioners today agree that the credit markets are broken (or at least severely sprained).
You do not think market prices can diverge from fair, fundamental, or intrinsic value for extended periods of time? Really?
Were you in the country during the dot com bubble? Have you taken a look at the TED spread recently? Do you think the evaporation of Lehman Brothers' and Bear Stearns' stock prices was simply a rational, if rapid reevaluation of those firms' assets and liabilities over the weekend? Ever heard of a run on the bank? What does a bank run have to do with intrinsic financial value?
Please, use your eyes and your brain. Do not read your prompts from an ideological cheat sheet.
Posted by: The Epicurean Dealmaker at Sep 25, 2008 4:25:27 PM
ya those securities are such a good deal that Buffet and Jack Welch have bought zero of them at the bargain basement prices.
Instead they have just been doing infomercials to convince taxpayers to buy the securities at outrageous "hold-to-maturity prices".
Posted by: gabe at Sep 25, 2008 4:48:10 PM
The picture of Pelosi, Bush, Obama, McCain, Reid had an unexpected emotional impact on me. These people are in charge of $700,000,000,000? This is our leadership?
Bartender, 16 shots of whiskey with vodka back, please.
Posted by: $9,000,000,000 Write Off at Sep 25, 2008 4:51:46 PM
Do you think the evaporation of Lehman Brothers' and Bear Stearns' stock prices was simply a rational, if rapid reevaluation of those firms' assets and liabilities over the weekend?
yes it was rational...people realized the companies were going under and they didn't have enough high ranking former CEO's running the treasury to save them.
JP Morgan(rockefeller) Chase happily cut a deal to unload all of Bear's toxic debt on the taxpayer and then fed off the carcass of it's former competitor.
People who knew this was coming rationally dumped and shorted the stock.
Posted by: gabe at Sep 25, 2008 4:52:25 PM
Mankiw defends the Fed...Anyone who ignores the bubble the Fed created in the 1920's after supposedly being created to "stabilize" the system is not reasonable. Anyone who acts as if the Fed is here to help the american people by "fighting Inflation" when it creates inflation is not legit.
Posted by: Gabe at Sep 25, 2008 4:56:07 PM
The argument rests on the first point, by reducing value uncertainty the feds will increase asset values. The Feds can buy now and reduce uncertainty later, making money.
I think I got it, I think it is wrong.
Posted by: Matt at Sep 25, 2008 4:56:13 PM
The entire premise of Mankiw's pitting of academic economists against Wall Street would seem to be undermined if you read what Soros and Buffett are saying. Both of them, clearly more Wall Street than academics, are arguing for the "warrants" approach instead of the auction approach. Here is Soros' piece on it, but Buffett argues the same thing:
http://www.ft.com/cms/s/0/9973c5b0-8a6d-11dd-a76a-0000779fd18c.html?nclick_check=1
Before you try the argument that academics are silly and don't understand things as well as "real economists" I think facts on who actually supports which plan are useful rather than accepting anonymous claims about what all of one group support. . .
Posted by: TS at Sep 25, 2008 4:59:08 PM
The outstanding open question is why markets don't now, pre-plan, successfully trade the toxic assets in sufficient quantities.
Markets haven't been pricing U.S. mortgage paper for over a year now, the Fed has: Bernanke & co. have been buying bad mortgages at artificially high prices. This has delayed a desperately needed creative destruction (of grossly inflated real estate prices, of the corrupt and wasteful GSEs, and of companies stupid enough to buy mortgage paper full of moral hazard). The Fed's propping up of mortgage paper has habituated financial institutions to having an artificially high floor on mortgage paper prices. When the Fed stopped buying -- something about putting the so much of the Fed's assets in bad mortgages (playing John Law) led to a weak dollar, extremely high commodity prices, etc. and the Fed "ran out of ammo" -- the bottom suddenly dropped out of mortgage paper. Because the Fed bought most but not all of the paper in many fungible classes, in many cases there is now too little of this paper in any one class left in private institutions to make a liquid market, and there is always a background threat that the Fed itself will dump this paper if there is a run on the dollar. Furthermore, the habituated holders of this paper now expect subsidized purchases to continue, this time from the U.S. taxpayer. Instead of selling at real market ("fire sale") prices bankers and other investors currently stuck with this paper naturally prefer to wait and let the taxpayer pay highly inflated Bernanke-says-so prices for their paper.
Bernanke's theory that one can avoid the tight credit and recessions he so obsessively fears by indefinitely prolong bubbles, the idea that the Fed can indefinetely put off creative destruction, has been proven wrong. Instead the Fed's artificial subsidy of mortgage paper prices has focused that destruction into a much shorter period, greatly increasing systemic risks.
The Paulson plan is to now have the taxpayer instead of the Fed artificially subsidize the paper, but it's not at all clear to me that Paulson or Bernanke have learned that if mistakes of timing are made, which they usually are, these mistakes can focus the creative destruction into shorter periods and thus increase systemic risk.
Posted by: Nick at Sep 25, 2008 5:04:52 PM
1) Mankiw isn't defending the intervention. He's been critical, and a friend sent him an email with counterarguments that he printed. So enough with the ad hominem stuff.
2) I have a different idea to throw out. If the urgency of an intervention supposedly stems from contagion to the commercial paper market, and the government is now going to play hedge fund anyway, why don't we dedicate the $700 billion facility to guaranteeing the commercial paper of high-quality borrowers for the next six months or so. We could even charge the borrowers a couple of basis points for the service. I'll bet that the taxpayer is a lot less likely to have to pay out much of that $700 billion with this strategy, and then we can use the appropriate tough tactics to flush out any insolvencies in the MBS and CDO markets at our leisure.
Posted by: srp at Sep 25, 2008 5:11:21 PM
Epicurean: If you really believe that, you should be buying calls on WAMU and other sterling operators. If you think the market is undervaluing these assets, you should be long the owners of them.
The usual retort to people who think the market is irrational is that they should put their money where their mouth is. (Note to Paulson & Co., that's their money, not mine.) Whatever the supposedly smart people are saying, the smart money is not buying this stuff.
Posted by: Jeff at Sep 25, 2008 5:29:48 PM
