By Chris | September 26, 2008
I’m not a Macroeconomist. And, I’m conflicted about the Paulson plan. But, given the recent unprecedented events, I figure I should chime in. A few thoughts:
I had a Macroeconomics test today. In our models we assume No Ponzi Schemes. Representative agents aren’t allowed to pay off their debts by borrowing more, and more and more. The current correction in the housing market is an imposition of a No Ponzi Scheme condition.
According to Robert Shiller, housing prices have lost 5 trillion dollars in value since their peak. He argues (in the link above) that more innovative mortgages could have alleviated foreclosures in the housing market. Interesting, but dubious.
A CNN video clip highlighted on The Daily Show put the 700 billion dollar bailout in terms of McDonald’s’ apple pies. According to CNN, 700 billion dollars is equivalent to 2,000 apple pies per American. I take issue with this for two reasons:
- Apple pies are 2 for 1 dollar so you should be able to give 300 million Americans 4,000 of them each.
- The bailout doesn’t cost 700 Billion, we are just authorizing 700 billion dollars to be used to lend to, and purchase equity in, struggling financial institutions. The bailout will still cost a lot of money on net, but it won’t cost 4,000 apple pies per American.
As a renter, I’m quite happy that housing prices are falling. I’m looking forward to getting more bang for my buck when I decide to purchase a home.
What would happen if the government just let these firms fail? Despite the widespread criticism of the Paulson plan, almost everyone agrees that the government needs to do something. Doing nothing risks financial catastrophe. Maybe government inaction is an experiment better tested in Second Life?
My biggest fear from the bailout is that it will irrevocably change America’s relationship with its financial institutions. We can’t socialize costs without eventually socializing profits. More stringent regulations of financial institutions means less innovation and less efficient markets.
Yet predictions of a sea change towards more invasive government are premature. The Depression witnessed a pervasive expansion of the federal government into numerous walks of life, from trucking and railways to farming, out of a broadly shared belief that capitalism had failed utterly. If Mr Paulson and Mr Bernanke have prevented a Depression-like collapse in economic output with their actions these past two weeks, then they may also have prevented a Depression-like backlash against the free market.