Tuesday, October 14, 2008

Government to rescue banks -- yikes

The US government joined with the Europeans to announce that banks will be forced to take on the government as a partner. Governments will presumably encourage banks to make good use of the funds they inject in exchange for an equity stake. And thus the irony: we got into this mess in part because government-sponsored banks (Freddie and Fannie) were "encouraged" to make ever-more-creative loans to those who couldn't afford or qualify for conventional loans, and now Washington is going to be encouraging banks to lend money they might not otherwise feel comfortable lending.

There is no substitute for the free market's ability to efficiently allocate resources. Government is probably coming to the rescue of the banks at just about the time that a rescue is no longer necessary. Government meddling in banks' affairs will likely retard the return to normalcy. This is not a reason to worry about a deeper recession, but rather a reason to not expect an economic boom any time soon.

No matter who wins this election, government has already won this round against the private sector.


Tory Conservative said...


I agree. All of this worrying about how banks won't lend to each other misses the underlying reason why they won't engage in such lending: There is fear that the banks have made bad decisions.

I hope that the FDIC will close down those banks that are truly insolvent and only appear solvent due to inflated values of their Mortgage Backed Securities.

How about this? A new regulation of FDIC insured banks: No FDIC insured bank can own any mortgage backed securities nor any mortgages where the borrower paid less than 20 percent of the appraised value as a downpayment.

Tory Conservative said...


Assuming an Obama victory and a net gain for the Democrats in the Senate of 7 seats (a 58-42 seat majority, including Lieberman), how do you see the economy performing over the next two or four years?

I realize that this is difficult to forcast.

We don't know how much of the Left-Wing agenda Obama is serious about enacting (I suspect he's serious about enacting most of it) and we don't know if the US House Democrats might resist some of that agenda. The Democrat controlled Congress of 1993-1994 didn't not even hold a vote on the Clinton health care plan.

But given the path that the economy is on right now, given that the Bush tax cuts are likely to expire (at least those that have an impact on investment and job creation), do you think it is possible that the unemployment rate could reach 8 percent sometime in 2009 or 2010?

Tory Conservative said...

I guess I will answer my own question this way:

Under President Bush the unemployment rate averaged less than 6 percent.

The only bread lines were the ones at Panera Bread when they were giving away free samples of their rosmary seasoned bread.

Under triple D government (Obama in the White House, Pelosi as Speaker, Reid as Majority Leader) lots of Democrats who used to be able to purchase things with the money they made with their jobs will be bumming for things.

Scott Grannis said...

The real question is whether things will get worse than what the market is implicitly forecasting. I see the market as extremely pessimistic and extremely cheap. That suggests that selling is not a good strategy at this juncture.

In any event, I think Obama will face real challenges trying to implement his tax program if the economy is still fragile next year.

The potential for a 3D government (all 3 branches under Dem control) to mess things up or fail in an attempt to force radical change is significant. Carter and the first two years of Clinton come to mind. Both were followed by dramatic improvements in government. So I don't see the need to give up hope completely.

Tory Conservative said...


I agree that America did rebound quite well after triple D government under Carter and Clinton.

But in the shorter term, my sense is that we might be in for a recession. The next President and the next Congress might have something to say about how long this recession is and how deep it gets.

Given that the Bush tax cuts are ready to expire and that the Democrats have spent the last year and a half calling it a failed policy, my sense is that we are going to get a real live "experiment" determining how important the Bush tax cuts were in stimulating the economy.

Most Republicans argued that the Bush tax cuts were essential for economic growth; the Democrats argued that the Bush tax cuts were a give-away to the rich.

What were the Bush tax cut worth while they were in effect? 0.5 percent of additional GDP growth? 1 percent of additional GDP growth?

I heard on CNBC this evening that Milton Friedman was asked in 1999 what policy he would recommend if the US were confronted by a possible depression. His reponse was "expand the money supply" and "cut taxes across the board."

We are about to find out how successful a policy of expanding the money supply is with a policy of allowing taxes to increase via expiration of the Bush tax cuts.

Scott Grannis said...

Supply-side theory emphasizes people's reaction to changing incentives. If a hike in tax rates late next year or in early '10 becomes pretty likely, the effect will be to stimulate the economy in the short-term, because people will want to accelerate income and gains and redeploy assets before the tax hikes. The economy will be surprisingly stronger in advance of the tax hikes, and then surprisingly weak after they take effect.