Marginal Revolution

From the Hill

“The House of Representatives is currently experiencing an extraordinarily high amount of e-mail traffic. The Write Your Representative function is therefore intermittently available. While we realize communicating to your Members of Congress is critical, we suggest attempting to do so at a later time, when demand is not so high. System engineers are working to resolve this issue and we appreciate your patience.”

Here is the story.  The associated explanation is this:

The House is limiting e-mails from the public to prevent its websites from crashing due to the enormous amount of mail being submitted on the financial bailout bill.

Gee, I wonder if all those people are for or against the bailout?

I thank Carrie Conko for the pointer.

Who is Greener?

There is a new InTrade.com contract, this one on whether oil futures and the Democratic President contract move in the same direction on Election Day.  Right now it's running at about 50 percent, which means an Obama victory won't on average bring a higher price of energy.  Mark Thoma directs us to this interesting article on the bursting of the Green bubble, most of all among the Democrats.

Is sanity on its way?

Maybe, just maybe:

The U.S. Senate may consider expanding the authority of the Federal Deposit Insurance Corporation as part of a package of legislation to reduce turmoil in the financial markets, Senate Banking Committee Chairman Christopher Dodd said today.

You'll note that the FDIC specializes in concentrating its actions on insolvent banks, which is exactly what we should be doing.  The FDIC also has experience in this area, believe it or not.

Did "minority lending" drive the crisis?

This is one of the queries I receive, in varying forms, every day.  Did policies such as the Community Reinvestment Act significantly worsen the housing bubble and the subsequent collapse?  Basically not, although in my view these were bad policies for other reasons.  They contributed to our current problems by only a small amount and of course these policies have been around for a long time before the housing bubble ever got started.  Here is one back-of-the-envelope debunking of the "diversity recession" idea.  Matt Yglesias links to some other debunkings.

You can, however, cite the general obsession with extending home ownership as strong evidence that putting Democrats in charge does not suffice to solve our regulatory problems.

Only polite comments will be left standing...

The problem is that both of you are right

David Brooks is right that the failure to pass the bailout represents a massive failure of American governance and leadership, most of all at the Congressional level.  That's true even if you think, for other reasons, that the bailout was a bad idea.  (Can any hero be cited in this debacle?)  Andrew Sullivan (and others, including myself) was right that early versions of the Paulson plan bypassed checks and balances and gave far too much power to the Executive Branch.  So Congressional oversight was needed.

That's the problem, namely that both of these views are right.  And this is just one reason, of many to come, why the Paulson plan (whether or not we need it) will not work as promised.

Should the Fed pay interest on deposits?

Steve Randy Waldman says yes:

I would support a standalone act authorizing the Fed to pay interest on deposits immediately. I would prefer that Congress impose limits on the quantity of deposits on which interest can be paid, to limit the risk and interests cost to taxpayers, but that limit could be quite loose for the moment. This approach has the advantage of getting liquidity into the banking system far more quickly than the Paulson Plan ever could have, and drawing a clear line between the liquidity and capitalization aspects of the plan. It could be implemented immediately by passing the one sentence Section 128 of the Paulson Plan in isolation (although again, I'd prefer to muck it up with a limit on the quantity of paid deposits).

Freed of its balance sheet constraint, the Fed might consider injecting funds into the banking system by purchasing a diversified portfolio of holdings in money market funds that trade in commercial rather than government paper. This would help relieve the stresses in the commercial paper market very directly, and reduce the likelihood of a disorderly adjustment in nonfinancial commercial credit markets.

On a different tack, here are some very good ideas from Paul Light, an expert on bureaucracy.  And did you know that the FDIC currently has the power to guarantee short-term interbank lending?  The Paulson plan was in fact quite slow, so maybe its failure will force us to look for other and better options.

Mexico fact of the day

Foreign banks account for 80 percent of the financial system in Mexico, 51 percent in Peru, 29 percent in Chile and 22 percent in Brazil.

Here is more on the general issue of international contagion.

The best and worst case scenarios

The best case scenario: The bad banks continue to be bought up, there is no run on hedge funds next Tuesday, only mid-sized European banks fail, money market funds keep on buying commercial paper, and the Fed and Treasury continue to operate on a case-by-case basis.  Since Congress doesn't have to vote for something called "a bailout," it can give Paulson and Bernanke more operational freedom than they would have otherwise had.  The American economy is in recession for two years and unemployment does not rise above eight or nine percent.

The worst case scenario: Credit markets freeze up within the next week and many businesses cannot meet their payrolls.  Margin calls cannot be met and the NYSE shuts down for a week.  Hardly anyone can get a mortgage so most home prices end up undefined rather than low.  There is an emergency de facto nationalization of banks to keep the payments system moving.  The Paulson plan is seen as a lost paradise.  There is no one to buy up the busted hedge funds, so government and the taxpayer end up holding the bag.  The quasi-nationalized banks are asked to serve political ends and it proves hard to recapitalize them in private hands.  In the very worst case scenario, the Chinese bubble bursts too.

I still think some version of the best case scenario is more plausible, but I wish I could tell you I am sure. 

Why not nationalize?

Megan McArdle piles on:

...what works in the banking system of a small economy does not necessarily work in a large one.  For starters, no offense to the Swedes, but very few other countries are affected by what happens in their economy.  One family, the Wallenbergs, indirectly controls something like 30-40% of Sweden's GDP.  Even now, the Swedish financial system is considerably less broad and complex than that in the US; it's not a world financial center.  And in 1992, everyone's financial system was a whole lot less complicated than they are now...

Possibly the biggest problem with this plan, among many, is that Sweden is essentially able to command the labor of its bankers; they have relatively few alternatives without starting over in a new country and a new language.  American government has no such leverage.  Yes, the folks in the mortgage departments royally screwed the pooch, but running a major bank is not something you can hand over to a GS-17.  Nor is it a job for academic economists. 

And, of course, the political ramifications in the United States are very disturbing.  A small homogenous country with a parliamentary system and a lot of social capital invested in the government is going to do better at nationalizations than we will.  The fractious structure of the American legislative system means--as we've just seen--that huge amounts of political maneuvering and log-rolling will go into the running of any national banking system.  Imagine the banking system run by the Department of the Interior.

...The problem with the Japanese system (or at least, one major problem) is that for political, social, and career reasons, banks kept pouring money into zombie firms, trying to salvage the bad loans of a decade ago.  Is a nationalized banking system less or more likely to do this than a private one, in America?  I imagine any banking head, appointed or career civil service, would get a lot of calls from Senators and congressmen demanding that the bank prevent companies in their districts from going under.

There's lot of talk in the blogosphere in favor of the Swedish plan, but not much consideration of its drawbacks. 

Words of wisdom from K. Harris

Money market trouble was the trigger, and it's back. The direct response was a $50 bln insurance fund, not in place yet. How about $200 bln in insurance, with a 15-minute turn-over for enrollment? Give the FDIC a green light - already backed by Treasury, so no legislation needed. Put everything in place that can be done without legislation and that directly addresses the issues that confront us, instead of issue that are behind other issues. Financial firms will need to worry about staying in business, but they won't have to worry about liquidity. Moral hazard is a lesser concern.

The big unfixable thing is that the government teased a hungry market and then jerked the bacon away. Can't fix that now, but there are other approaches to the problems we have.

He is a commentator over at calculatedrisk.blogspot.com.  My personal, oversimplified rule of thumb is that as long as trading continues The End of the World has yet to come.

It's also worth considering the new equilibrium.  If things do not totally tank right now, Paulson and Co. truly have zero credibility -- for better or worse -- the next time they claim that some particular policy action has to be done.