How Not to Save the World: What should we do about toxic assets?

by Charles Krakoff on March 23, 2009

in Crisis

Paul Krugman, who won last year’s Nobel Prize, is one of the most talented economists working today, and also one of the best writers in the profession. He is a liberal Democrat and I am not, but his op-ed piece in today’s New York Times is the best dissection I have yet seen of the flaws of the latest bank rescue plan which, as Krugman points out, is essentially a rehash of the original, and failed, Bush-Paulson Troubled Asset Recovery Plan (TARP).

I won’t try to paraphrase Krugman’s article here; he says everything that needs to be said far more eloquently than I could, and you should definitely read the article, available on http://www.nytimes.com/2009/03/23/opinion/23krugman.html?_r=1&ref=opinion. It is right on every count.

The  Obama Administration’s essential problem is that for all of the President’s talk about making tough decisions, he wants to avoid offending anyone and has consequently come up with a plan bound to offend almost everyone, while failing to resolve the underlying issue: what to do with the hundreds of billions of dollars in bad assets weighing down the banks’ balance sheets and preventing them from lending.

President Obama may think he can avoid giving more red meat to Rush Limbaugh and his followers by steering around the only workable solution, which is to nationalize the failed banks, strip out the bad assets, restructure the banks, and then sell them back to the public. This, he fears, would be proof of his “socialist” agenda. So instead he has proposed a far more dangerous plan, socialist or not, which is to subsidize the purchase of these bad assets by private investors, essentially using taxpayers’ money to inflate their value.

With my libertarian political leanings I instinctively fear anything that increases government ownership of or intervention in business, but in these times I see no alternative to large-scale government intervention to save the financial system on which the entire world economy depends. The prevailing sentiment seems to be that government has to do something – anything – immediately to prevent a total collapse, but as so often happens, the prevailing sentiment is wrong. Doing the wrong thing is worse than doing nothing at all. If the President follows through with the plan, details of which Treasury Secretary Geithner is to release today, we will have borrowed and spent who knows how many hundreds of billions of dollars and will remain saddled with a badly crippled banking system.

I do part company with Krugman on one point. He has argued in favor of an even bigger fiscal stimulus package than the $789 billion one passed a month ago, but I have some grave doubts about its likely effectiveness and even its necessity. In spite of the continual depressing news about negative economic growth, the decline in world trade, factory closures, and job losses, we will ultimately climb out of this recession as we have done in every previous recession. This recession is a direct consequence of the financial crisis, and unless we fix the banking system correctly and soon the climb will be steep, long, and hard.

If President Obama enacts the policies needed to fix the financial system history will judge his presidency a success. If he follows the present course nothing else he may do over the next four years will matter. He will have failed, and all the hopes about restoring America’s reputation and position in the world will have been shredded. Unlike Rush Limbaugh, I desperately want President Obama to succeed. In the near term, the best he could do would be to heed Paul Krugman’s advice.

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