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We’ll all be worse off

It appears that a fair number of my online penpals is cheering the failure of the bailout plan in Congress. I’ve been making rounds recording my disagreement with their point of view – and at some point, I realized that I need to state my opinion in my space as well.

The objections to the plan run mostly along the lines of “how can we spend so much of taxpayers’ money to let those who caused the whole mess off the hook?” I happen to think that that point of view is terribly misguided.

You know who is going to suffer the most if the current financial crisis keeps spiraling downwards? The middle class. Not the rich – they will simply become less rich, but stay rich nonetheless. Not the poor – please forgive me my inadvertent snobbery, but the poor have little to lose, by definition. The middle class, conversely, will lose a lot when the corporations and consumers tighten their belts and spend less and less. A florist will not be able to sell her stock of roses, a waiter will earn fewer tips, a fledgling online business will see fewer orders. Thousands of corporate soldiers will be out of jobs. Many will lose their houses. Some of them may deserve it, on account of buying houses they could never afford. The vast majority will be innocent bystanders.

The Great Depression destroyed a few financiers. It destroyed a lot more of Average Joes. The unemployment rate hit 25% then, and the number of mortgages in default swelled to 40%. We are nowhere near those numbers right now (6% and 4%, respectively), but we are sliding towards that. Shouldn’t we be trying to take some action?

The recovery in 1933 arguably jump-started with federal cash infusions via the Reconstruction Finance Corporation and the Home Owner’s Loan Corporation. In early nineties, the Resolution Trust Corporation dealt with S&L failures of the previous decade. Those were admittedly created years after the crises hit. But they provide a reasonably successful template. One that can be used now.

The plan would effectively transfer the burden of owning “troubled assets” from shareholders to taxpayers, and in the process deepen the budget deficit to somewhere above 6% of GDP. Yes, that is not fair to taxpayers, on the surface of it. But there is a fair chance that some of that money will be repaid (RTC did turn a modest profit even, didn’t it?). And what’s more important, the cost of after-the-fact unwinding of financial crises around the world in the last 30 years averaged 16% of GDP. Going with the Bernanke/Paulson proposal, in effect, should cost considerably less than sitting on our asses waiting for the natural bottom to hit in a few years. We do nothing – and we all suffer, some of us possibly losing everything in the process. We follow this plan – and there is a fair chance of stabilizing the economy to the point where other harsh decisions, regarding how to prevent this from happening again, can be made.

Update: And you know what, all of you who cite economists signing letters criticising the bailout? It’s all about whom you’d rather trust. Quoting Harward economist Greg Mankiw (emphasis mine),

Ben [Bernanke] is at least as smart as any of the economists who signed that letter or are complaining on blogs or editorial pages about the proposed policy. Moreover, Ben is far better informed than the critics. The Fed staff includes some of the best policy economists around. In his capacity as Fed chair, Ben understands the situation, as well as the pros, cons, and feasibility of the alternative policy options, better than any professor sitting alone in his office possibly could.

If I were a member of Congress, I would sit down with Ben, privately, to get his candid view. If he thinks this is the right thing to do, I would put my qualms aside and follow his advice.

P.S. Yes, I lost huge sums of money on the stock market in the last year-plus, even though I’m well-diversified with investments in what I would describe as “solid” companies. The bailout would benefit me in a very direct way. I’m mentioning this so no one doubts my motives.


  1. Eric

    You’ve mostly persuaded me, at least. I’m not sure I’ll ever be 100% comfortable with a bailout, or with the bailout plan that was rejected, but the consequences look bad and one of the leading reasons I’m seeing for rejecting the bailout–punishment or retribution–is simply illogical. (As I sort of said on Jim’s blog, it’s cutting off our noses to spite our faces if the only people who suffer the retribution are the victims.)

    Anyway, thank you for making one of the strongest cases I’ve seen for the bailout.

  2. Sharon

    Well played, Ilya. To be fair, I don’t believe that many of those voicing angst over the Bail-out/Buy-in truly intend this action should never be taken at all. (Main Street, after all, has been hurting on a very tangible level for quite a while now, too.) It’s merely the sinking in phase that rankles.

    Many of us saw the inevitability and necessity of this coming last August (I was one of them); others have seen this coming much further back as the housing bubble swelled (I wasn’t one of them).

    I see little harm in the relatively short period of time the give-and-take adjustments have taken up these past two weeks as the self-imposed ‘deadline’ of this past Monday was a moving target anyway, intended as much to quell the world markets as home turf.

    Now cooler heads will prevail here and the US — Jane Q. Public, et. al. — will soon get on with what needs must.

    P.S. I got out of the stock market Spring 2007 just in time and so dog in the hunt there. But I do have a vested interest in the LIBOR, dollar strength, home sales activity and the currency exchange rate.

  3. Ilya

    Thanks, Sharon. And I wish I was a bit smarter in strangling my inner “long-term investor” when the signs point to getting out of the market. Happy hunting 🙂

  4. Sharon

    Ilya, I wish I could brag that it was foresight or insight on my part in getting out of the market when I did. But the truth is, it was blind stupid luck; I needed the funds as collateral on a venture that didn’t come together and only inertia prevented my immediate re-entry into the market.

    It’s one of the few times my laziness has come off looking like clairvoyance. 🙂

  5. Ilya

    Curiously, that mirrors very closely my own claim to “clairvoyance” in taking the money out of the market in early 1999 – that was when we bought our house.

  6. Jim Wright

    Ilya, my thoughts for a bailout plan are up on my site. Since you’re the one who spurred me to think long and hard about a solution, as opposed to a bailout, I thought you might be interested. And as somebody who works in the investment field, I’d like to hear your thoughts on it. -Jim

  7. Ilya

    Jim, I read it and I have nothing but best things to say about it (I stated so in my comments). I think it would work and offer a real hope, if only we could rely on our politicians – and economists, for that matter, – to think outside of the box.

    Everyone else, if you read my blog but do not read Jim’s, I still suggest that you take time to read his brilliant article –

  8. BDS$

    I can see why a Brit would like this since it’s all about US Taxpayers paying for Euro/Chinese bad bank debt – the chief crooks Paulson/Bush threatened a veto unless a provision was included to buy foreign bank bad debt. That is what 9 out of 10 US citizens are hopping mad about. I wish all US citizens would read the document outlining the theft….

  9. Ilya

    Thanks for coming, BDS$, and stick around enough next time to learn that I am a US citizen and a US taxpayer.

    You seem to be quite well informed about how many people actually read the bill before calling into whoever they called – I wish I had similar insight.

  10. BDS$

    Glad to be here – Got it – your merely relocated to the UK. Well, a US citizen, a taxpayer, and may I assume you have read the bill? I’m wondering how any US taxpayer could be for bailing out non-US banks that made bad bets?
    I am, of course, assuming the people calling and faxing our fearless leaders (if you listen to our news agencies you would believe that buying bad debt from the banks actually has a chance in making a profit) have read the bill but the 9 out of 10 against is from the “leaders” mouths on various interviews.
    I’m not saying we do nothing, nor do I propose to know what to do. I think one way of approaching it is to get some independent ideas from economists and make our best judgement…

  11. BDS$

    By the way, I’m one who thinks of himself as a Republican – who voted for Bush two times because the alternate would have made us “worse off”. Looking back on those decisions, I don’t know how. I hope this board doesn’t mind some contrary input as most seem to back the plan. I’m trying to understand that logic because, as I’m sure you can tell, I’m very convinced it will worsen an already bad situation. I mean, really, have the banks agreed to lend the money if we give it to them? It’s my understanding they continued to hoard cash in the 30’s after a similar cash infusion?

  12. BDS$

    By the way, the Economist you mention provides no details on why we should support Bernanke ( just believe in him?). Jim Rodgers recenty referred to him as an idiot. Bernanke has been consistently wrong in stating how strong the fundamentals were and then the next crisis would occur, the next plan would pop out, the prime would be lowered, and commodities would soar, causing pain for the world. Incompetent is a more appropriate term for someone that is consistently wrong or ineffective. How naive.

  13. BDS$

    LLya, why don’t you just say that you are afraid to lose money in the stock market short term and don’t care if it requires you to sell out the future of our country to prop up the market? One more pop and you could get out an minimize your loss before the inevitable crash. Just some direct communications to a fellow taxpayer – it this bill goes through, you and your family will be paying for it for a long time.

  14. Ilya

    may I assume you have read the bill?

    Yes, I have. It’s not perfect.

    I’m wondering how any US taxpayer could be for bailing out non-US banks that made bad bets?

    When you kindly point to me where I argued for something of the kind, I’ll be happy to try to answer that.

    My argument has been that a federal cash infusion is the only thing that can stabilize the economy, and that without such stabilization an average American consumer will suffer on par with the Great Depression. Many economists – even those who oppose the bailout in its current form – ultimately agree that such infusion is necessary. I submitted numbers that show the cost of bailout to be about a third of the final cost of letting an average financial crisis run its bankruptcy-ridden course. I also argue that we are too near the catastrophe to dawdle around and wait for armchair theoretics to come to a meeting of minds on what’s the ideal approach.

    The soundbites about bailing out fat cats – and now non-US banks? – completely disregard what is likely to happen without such infusion (recall 25% and 40%). As such, I do not find them acceptable or meaningful.

    have the banks agreed to lend the money if we give it to them? It’s my understanding they continued to hoard cash in the 30’s after a similar cash infusion?

    The recovery started at around that point. The credit markets gradually became un-frozen and liquidity grew. Some lenders will be more aggressive, the others more cautious. But the universal credit freeze will start lessening.

    No one suggests that there is a Big Bang effect with the infusion and that our worries will be immediately resolved.

    By the way, the Economist you mention provides no details on why we should support Bernanke

    Yes it does. You need to read a bit more carefully. It suggests that a person who is in the middle of something is much better positioned to offer a remedy than any number of armchair theoretics who’ve never lifted a finger in their lives when it comes to public policies. I reasonably do not expect anyone to be infallible all the time; I reasonably – we can delve into the actual numbers related to his predictions, if you want, away from soundbites, – hold that Bernanke is a more competent economist than the vast majority of those who attack him; I reasonably expect a practician with a lot of tools at his disposal to be in a better position to judge anything than an idle theory wonk.

    (By the way, Jim Rogers called Bernanke a nut – I don’t think that there was an “idiot” anywhere in that conversation, but it so much more powerful to use that in an argument, doesn’t it? – because he disagreed with something. I do not know if that is any gauge of anyone’s competence, to tell you the truth.)

    Just some direct communications to a fellow taxpayer – it this bill goes through, you and your family will be paying for it for a long time.

    I pay a lot of taxes without having any direct input as to how they are apportioned. I might be totally off base here, but I did not see any new taxes associated with the proposal. So the inflaming rhetoric about me, as a taxpayer, “paying for it” falls a bit flat. It’s not like I’d be paying any less taxes if no federal action is happening.

    What I know is that if this bill does not go through, many people might lose jobs, houses and life savings. Yes, the health of my stock portfolio is extremely important to me. But that does not diminish my concerns for getting to 25% and 40%, respectively. The proposal is a win-win, really.

    I hope this board doesn’t mind some contrary input as most seem to back the plan. I’m trying to understand that logic…

    This is not a board, but rather my private blog. I have nothing against people who put forward opinions that contradict mine, but I reserve the right to moderate – or ignore – anything that I find being light on constructive suggestions and logical or factual rebuttals while simultaneously being heavy on insisting that I simply cannot be right.

    There are some deficiencies in the presentation of my argument, but I believe it to be quite clear in terms of logic and coherence. You may need to re-read it again, if the logic still escapes you.

    Your first couple of comments were ok, but then your tone turned to the worse. I can’t say that I appreciate it.

    By the way, the name is I-L-Y-A. I suppose it’s too silly to point out that in this thread, the repeated salutations of ‘Ilya’ cannot all start with a lower-case letter.

  15. BDS$

    I apologize for mispelling your name. I would like to point out one unmistakeable fact – the bill passes – and the market drops 157 points. The market has spoken and I rest my case.

  16. Ilya

    The simple response to that would be a quick recollection of how much the market fell when the bill was initially rejected – 777 points. What was the market saying on that day?

    The more elaborate response would be going into the details of how stock markets work, of trading on expectations, of upward trends leading to turning-point events, of locking in gains in times of overall downwards trending, and so on. I have neither time nor inclination to go to those lengths.

    Come back in a year or so, and we’ll see what the market actually said.

    P.S. In case you’re wondering why you’ve been moderated, submitting a series of comments in quick succession with whatever thought crosses your brain is marginally acceptable once, but hardly acceptable in repeat. I’ve let the first of those comments through only because it was the only one that contained a point worth a response. The others were deleted, and your ability to post a new comment is now approval-restricted.

  17. Brian Greenberg

    Ilya – thanks for your thoughts on the financial crisis. I’ve been composing my own thoughts in the form of a longer, more expository take on what has gone on. I’m hoping it serves to clear up some of the many misconceptions that have been peppering the press, the politicians, and the blogs lately about all that’s gone on and what it means going forward.

    I’m afraid I haven’t gone as far as offering a detailed plan to fix it, but I think it’s important to have a reference point to understand the past before we discuss the future.

    If you and the other commenters here have the (significant) time required to read through it, I’d appreciate all of your thoughts & comments.


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