Thursday, October 2, 2008

The Bailout Plan

Economists are divided on the current version of the Treasury's bailout plan. Nobody really likes it, but some believe it is necessary while others argue that it is worse than doing nothing. Here are two good examples, one of each.

Jeff Frankel explains why the current version of the plan ought to be supported. John Cochrane argues to the contrary that this plan is akin to blowing up the dam to prevent boats from sinking.

I think that the current bill is no panacea. But I think that the odds of Congress producing a better bill in the near term are close to zero. So the question is whether this bill is better than nothing. The answer depends partly on how close we are now to a credit meltdown (this article suggests that things are getting worse, as does this one). I think we are close. But as John Cochrane points out this is not sufficient. We have to ask whether this plan will work. John argues that the core of the plan requires "magic" to be successful, as it will not inject sufficient capital into the banking system. Ithink that the essence of the plan is for the government to act as a giant arbitrager (Uncle Sam is bigger even than Warren Buffet) and can purchase underpriced assets that have depreciated due to deleveraging. This can provide some support to the banking system till we can implement some additional reforms.

The big problem is that this is hardly the end of the process of shakeout in the financial sector. It is barely a start.

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