Paulson’s Plan

September 25, 2008

The joke goes that if you lined up all the economists in the world from end to end, they still wouldn’t reach an agreement.

There’s some truth to this joke, in particular when dealing with macroeconomics. Economists still don’t really know what causes business cycles, or whether “aggregate demand” is something we should really be worried about.

Given the reputation of economists, particular attention should be paid to matters on which there is agreement. Rent control laws are universally opposed by economists, no matter their ideological background, because they are both economically inefficient, and hurt the very people they are intended to help. Some economists are skeptics on free trade for all nations, but the supporters far outnumber the skeptics. If you narrow the question to large economies like that of the United States, the numbers would be even more lopsided.

I have yet to read an economist of any stripe who believes that Treasury Secretary Paulson’s plan to buy $700 billion in mortgage assets is a good idea. The alleged justification for the plan is that there is no market for these assets outside of the US Government, and so the Government must buy the assets to keep money flowing within the economy.

First of all, if there is no market for these assets, how is the Government going to know the right price to pay for them? Using markets, as Hayek pointed out, is the only way to figure out what something is worth. There’s just too much dispersed information out there to be aggregated by any other method.

Secondly, as every economist has pointed out, if the Government expects to make money, because these assets have some underlying value, why isn’t anyone else willing to buy them? The US Government has a lot of money, and has the patience to wait a long time for these assets to unwind, but it’s not the only Government in the world. The Chinese have billions of dollars; Warren Buffett and Bill Gates have billions of dollars. If this is really an investment opportunity, it’s hard to argue that the US Government is in a unique position to take advantage of it.

New York City has rent control or rent stabilization laws that cover something like 80% of apartments. The Hawley-Smoot tariff, whose enactment was one of the larger factors causing the Great Depression, was passed, despite opposition from economists, 1,028 of whom signed a petition against it.  So what are the odds of Secretary Paulson’s plan being passed by Congress? InTrade says 90%.

Maybe Congress can throw on an amendment to this bill mandating greater use of ethanol, for good measure.

Addendum: I overstate things when I say that no economists are in favor of this plan. Greg Mankiw posts a defense, though I find it unpersuasive, and it doesn’t explain why only the Government can take action.

On the other side, Arnold Kling writes,

It sounds to me as though Bailie Mae is going to be wearing a big sign around its neck saying, “Adversely Select Against Me.”

This is what happens when you commit to buying assets for some reason other than “they are worth at least as much as I intend to pay.”

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One Response to “Paulson’s Plan”

  1. tripinchina Says:

    Ah, the notorious Smoot Hawley….I agree with you! (even as I furrow my brow in a vain attempt to understand the situation)

    I liked Krugman’s take on the whole thing. Also, the former finance minister of Sweden wrote a fairly interesting piece:

    http://www.nytimes.com/2008/09/23/business/worldbusiness/23krona.html?_r=1&scp=1&sq=sweden%20finance&st=cse&oref=slogin

    Or at least I have the sense that it *would* be fairly interesting, if I understood it.

    Right now I’m taking a class on Asian Political Economy (which is kind of ridiculous since I haven’t taken macroeconomics) and it is more than a little ironic that we’ve been studying the asset bubble in Japan and the subsequent banking crisis. The Japanese government was so conservative, pushed this way and that by various factions, that they essentially did nothing. Which didn’t turn out well for Japan!

    So I wrote a vague blackboard post suggesting that the institutions in Japanese government displayed a conservative bias, since industry leaders and the Bank of Japan were all pushing their own agenda and the result was adversity to change.

    I guess Congress displays the opposite affliction; i.e. an inappropriate bias towards an activist press-friendly response…which could also prove disastrous.


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