Matt Yglesias

Structural Shifts and Bailouts

Richard Florida, sounding a skeptical note about bailouts, says we need to look to structural shifts:

The bailouts and stimulus, while they may help at the margins, also pose an enormous opportunity costs. On the one hand, they impede necessary and long-deferred economic adjustments. The auto and auto-related industries suffer from massive over-capacity and must shrink. The housing bubble not only helped spur the financial crisis, it also produced an enormous mis-allocation of resources. Housing prices must come a lot further down before we can reset the economy – and consumer demand – for a new round of growth. The financial and banking sector grew massively bloated – in terms of employment, share of GDP and wages, as the detailed research of NYU’s Thomas Phillipon has shown – and likewise have to come back to earth.

I think we need to distinguish between the bailouts and the stimulus here. And then within bailouts, we need to distinguish between the auto bailout and the financial sector bailouts.

So, starting with bailouts. The problem comparing the two bailouts is that social justice considerations and economic considerations point in different directions here. The auto workers are sympathetic claimants in a way that nobody in the financial sector is. But Florida’s point about the need for structural shifts has a lot more force in the auto case. In principle, the funds spent (and to be spent in the future) on the auto bailout could have been put directly into auto workers’ pockets while Chrysler and GM were put into government-sponsored debtor-in-possession financing. That would have achieved similar social justice ends without retarding necessary sectoral adjustments toward a world in which somewhat fewer automobiles are made. That said, the total quantity of funds involved in the auto bailout has been relatively small compared to the financial bailouts.

On the financial bailouts, it’s true that the size of the financial sector needs to shrink. But the bailouts are not preventing that from occurring—it is shrinking. And hopefully it will continue to shrink, in relative terms, as we move into recovery. But the point I would make here is that it’s extremely difficult for the needed sectoral shifts to happen absent a functioning financial system. The point isn’t that we need looser credit card rules so that people can go back to spending money they don’t have on short-term consumption. But if we want there to be more employment in the future, people are going to need to start some new businesses. And some existing businesses that aren’t auto companies, banks, or homebuilders are going to have to expand. And it’s very hard to expand without the ability to access credit markets. When people say that we need to “get credit flowing again” I sometimes worry that they’re talking about re-inflating the housing bubble, or getting us back to households having negative savings. That’s credit. But credit that’s used to finance productive business activities is necessary for sustainable economic growth.

On stimulus, I think that how well this turns out will ultimately hinge to some extent on the success of the programs. In principle, the stimulus spending—which largely goes to infrastructure, to education, and to health care—ought to greatly facilitate economic transition to the kind of “creative” economy Florida’s envisioning. To the extent that that money winds up wasted on programs that are ineffective we will have bought short-term demand at the price of stalling on long-term adjustments. I’d still say that’s a price worth paying, all things considered, but obviously it’s a good deal worse than a scenario in which these investments turn out to pay off in the long-run in the form of a healthier, better educated population able to move on better transportation and take advantage of faster broadband.

Detroit Wants $14 Billion More

Anyone who thought the last dose of auto bailout money was the last we’d be asked for was kidding himself, and anyone who thinks this $14 billion request will be the last is also kidding himself. The trouble, though, isn’t really the price tag. It’s the conflicting goals of the enterprise. Amidst an enormous recession, there’s a fairly compelling case for spending money on this scale as what amounts to a jobs policy. Standing by and letting the level of unemployment shoot up further would not be helpful to the larger macroeconomic situation. But to really do this right would amount to the management and owners of the companies just admitting defeat, and saying they want the government to keep their assembly lines running as welfare cases. They don’t want to do that for a whole variety of reasons. Instead they want to say that this is part of a plan to save their companies and the “domestic” auto industry. But that means cutbacks:

In return, the two companies also promised to make further drastic cuts to all parts of their operations, in the hope that they can eventually strike a balance between their bloated cost structures and a dismal market for new car sales.

G.M., for example, said it would cut 47,000 more of its 244,000 workers worldwide; close five more plants in North America, leaving it with 33; and cut its lineup of brands in half, to just four: Chevrolet, Cadillac, GMC and Buick.

There’s a business case for big layoffs. GM is hardly the only firm undertaking them. But if spending tens of billions of dollars on a jobs program makes some sense, spending that kind of money to help keep the management and marketing infrastructure of the firms in place as they layoff and furlough their workforce doesn’t. But you sort of need to choose what you’re doing here—are taxpayers creating makework jobs to prevent the rust belt from becoming the new dust bowl, or are we trying to provide assistance to our “national champion” firms and help them compete? If it’s the jobs we care about, we’d probably be better off spending the money giving different jobs to auto workers—spend $14 billion+ on Detroit to Chicago high-speed rail or something (ditches, anything)—which would have the same beneficial employment effect, avoid bailing out shareholders and managers, and help reduce auto industry overcapacity thereby lending a helping hand to Ford and to U.S. production of “Japanese” cars. Otherwise, if every country around the world insists on sinking more and more money not into its nation’s car companies instead of into its people who work for car companies then we’ll have a situation where the whole industry just keeps shrinking and sinking slowly.

$350 Billion, Not $2.5 Trillion

$350 billion dollars is a lot of money. And that’s how much the Treasury committed yesterday. Not $2.5 trillion. A headline like “Bailout Plan: $2.5 Trillion and a Strong U.S. Hand” is pretty misleading. The article text is (as is often the case) better:

Administration officials committed to flood the financial system with as much as $2.5 trillion — $350 billion of that coming from the bailout fund and the rest from private investors and the Federal Reserve, making use of its ability to print money.

We shouldn’t sneer at $350 billion. Eighteen months ago there were lots of social welfare that Barack Obama (or Hillary Clinton or John Edwards or Bill Richardson) could have embraced to endear himself to Democratic Party primary voters except advisers would come back and say “Senator, that’ll cost $350 over ten years—we can’t do it.” But it’s a much smaller number than $2.5 trillion.

The Stimulus Argument

Josh Marshall says: “Whatever we think of the long-term or even the medium-term fate of the US auto industry, it’s hard to think of many other stiff accelerants to the downturn than one of more of the big automakers going bankrupt any time in the next year.”

To me, this is by far the most persuasive case for a bailout for the car companies. If they were facing bankruptcy amidst a period of okay economic growth, I’d be strongly inclined to spend $38 billion on direct assistance to the state of Michigan and to displaced workers, feeling the best thing for the economy would be to liquidate firms that need liquidating and help people find work elsewhere. But at the moment, no matter what you did nobody could find new jobs elsewhere. Under the circumstances, giving money to GM to keep producing cars makes a certain amount of sense just as make-work. Ideally, it’d be better to employ all those people in infrastructure projects instead but the quantity of useful “ready to go” infrastructure projects is actually smaller than the volume of stimulus being contemplated, so that can’t be done on the necessary time frame.

That said, it’s important to keep in mind that there’s a tension between bailing out GM as a jobs program and bailing out GM as part of an alleged restructuring program that leads the firm to profitability. The plan GM submitted to the congress, for example, calls for both steep cuts to its workforce and for substantial union givebacks. Reduced production of vehicles is presumably part of that picture (to match reduced demand) which, in turn, means lower orders for suppliers. That’s business. But it’s not stimulus. The logic of stimulus is that we should be making the cars whether or not they can be sold at a profit just for the sake of keeping people employed.

Moral Hazard

Eric Dash writes for The New York Times:

But longer term, the new bailout could haunt regulators and taxpayers. The move ultimately may encourage banks to take more risks in the belief that the government will step in if they run into trouble.

Um . . . yeah. Look, I think these concerns about moral hazard can be overrated. Looking back on Lehman Brothers, plunging the entire world economy into a downward spiral just to teach a lesson to some uppity investment bankers doesn’t look so smart. But Paulson is proceeding as if this isn’t a concern at all. Or, rather, as if the health and welfare of wall street managers and shareholders is his primary responsibility. Sending such a giant pile of money over to Citigroup without removing the management, without clawing back the fortunes the management earned creating the mess, without adequately diluting the ownership stake of the bailed-out shareholders, and without taking any control on the board of directors is ridiculous. And, frankly, I didn’t see or hear the level of outrage from the incoming economic team that one would like to see.

Sweetheart Deals

I’m prepared to be convinced that some form of assistance for Citigroup was necessary, but this looks like a sweetheart deal to me:

The 11th hour transaction, announced just before midnight on Sunday in the US, calls for Citi to absorb the first $29bn in losses it sustains from its portfolio of risky assets – from residential mortgages to commercial real estate and leveraged loans, collateralised debt obligations and auction rate securities. Federal government entities will stand behind 90 per cent of the remaining losses, which could amount to $249bn. [...]

Under the terms of the arrangement, the US Treasury will invest $20bn in Citi preferred stock under the federal government’s troubled asset relief programme (Tarp) and receive dividends at a rate of 8 per cent annually. On top of that amount, Citi is receiving an additional $7bn in return for preferred shares issued to both the Treasury and the Federal Deposit Insurance Corporation for their roles in guaranteeing the risky assets. [...]

Gary Crittenden, Citi’s chief financial officer, said that last week’s plunge in the bank’s share price, from $9.36 last Monday to $3.77 at Friday’s close, was “very concerning.” At Friday’s share price, the bank’s market capitalisation stood at a mere $20.5bn, according to Bloomberg.

If I understand this correctly, the government just took a company that’s worth $20.5 billion, and gave it $27 billion in exchange for some preferred stock. And then on top of that, we gave them valuable guarantees. Stock is nice, but if we’re handing over to Citigroup more money than the company is worth and taking additional measures on top of that to assist the company, shouldn’t existing shareholders be wiped out? Maybe that’s happening somewhere in the fine print here, but The New York Times says the government’s shares “will pay an 8 percent dividend and will slightly erode the value of shares held by investors.” That sounds like a nice gift for Prince Alwaleed bin Talal of Saudi Arabia and Abu Dhabi’s sovereign wealth fund. Not sure why it serves the interests of American citizens.

UPDATE: Krugman “A bailout was necessary — but this bailout is an outrage: a lousy deal for the taxpayers, no accountability for management, and just to make things perfect, quite possibly inadequate, so that Citi will be back for more.”

UPDATE II: Tyler Cowen: “Ugh.”

UPDATE III: See also Kevin Drum’s questions at the end.

The Myth of the $70/hour Job

You may have heard that UAW members working for the Detroit firms make $70 an hour. That’s a lot of scratch. Forty hours a week, fifty weeks a year, and you’ll be earning $140,000 a year. Which makes you wonder why there are all these people wasting time in law school. Except as John Cohn writes it’s not true. The way you get the $70/hour figure is that you take the total costs of paying benefits to retired auto workers — legacy costs wracked up long ago — and then average that out over the number of current employees. The big three used to have a much larger share of the US market and manufacturing techniques used to be less efficient, so their past workforce was much larger than their current workforce. Consequently, the per worker figure is astronomical.

Now that was a real problem for the Big Three. It was, frankly, an idiotic thing to agree to. In exchange for getting to pay their workers less in the short-run, they agreed to a benefits structure that was guaranteed to destroy the firms in the long-run unless they could perennially maintain a huge market share. But it’s also a problem that’s largely in the past thanks to an agreement reached last year to offload and ultimately shrink the size of these costs.

All things considered, I think I still prefer the idea of prefab bankruptcy for these firms combined with massive stimulus outlays to the idea of bailing the firm out. But nobody should let themselves think that anyone is making $70 an hour building cars.

Bankruptcy Is Bailout

One of the confusing things about the drive to provide some kind of bailout to GM and other car companies is that discussion often seems motivated by the notion that if a firm can’t pay it’s bills then everything just somehow vanishes. But as Justin Fox says, the bankruptcy code provides an established process for what amounts to bailing out an insolvent firm. As Brad DeLong says, there’s a specific problem with letting a bank go bankrupt so instead of bankruptcy you get special bailouts to prevent everyone else from getting screwed over. But a car company is not a bank and doesn’t share the relevant properties of a bank. And bankruptcy is a form of bailout.

Two things we know about the outlook for the car industry is that there is going to continue to be demand for cars and other sorts of vehicles for the foreseeable future, and also that the operations of the “big three” firms aren’t going to become profitable without some substantial restructuring of the business. One way for that restructuring to happen would be for congress to try to serve as financier and central planner of the auto industry. Another way would be to let the bankruptcy process unfold. And there’s no reason for us to experiment with socialism in this regard. Spend federal money on helping people in need meet their needs, but trying to step in and dictate the specific course of change in the industry is folly.

Mo’ Money

AIG is getting more bailout. This doesn’t make a bailout for automakers a good idea, but in political economy terms I think it certainly makes the calls harder to resist. Next thing you know broader-and-broader swathes of the world economy will resemble the airline industry where successive rescues means nobody ever goes out of business and the whole sector becomes dysfunctional and dominated by unprofitable and terrible zombie firms. Just saying.

Fun With Tax Giveaways

Amit Paley reports for The Washington Post on a staggering tale of an illegal windfall for banks inserted into the $700 billion rescue package by the Treasury Department. “Did the Treasury Department have the authority to do this? I think almost every tax expert would agree that the answer is no,” George K. Yin, the former chief of staff of the Joint Committee on Taxation, told Paley. “They basically repealed a 22-year-old law that Congress passed as a backdoor way of providing aid to banks.”

The financial world was fixated on Capitol Hill as Congress battled over the Bush administration’s request for a $700 billion bailout of the banking industry. In the midst of this late-September drama, the Treasury Department issued a five-sentence notice that attracted almost no public attention.

But corporate tax lawyers quickly realized the enormous implications of the document: Administration officials had just given American banks a windfall of as much as $140 billion.

The sweeping change to two decades of tax policy escaped the notice of lawmakers for several days, as they remained consumed with the controversial bailout bill. When they found out, some legislators were furious. Some congressional staff members have privately concluded that the notice was illegal. But they have worried that saying so publicly could unravel several recent bank mergers made possible by the change and send the economy into an even deeper tailspin.

Read the whole thing, as they say.

Bubbles Instead of Income

Atrios remarks:

Some people losing their homes were victims of bad lending practices. Some people, however, saw their houses as ATMs. In some cases people might have been pulling out money to fund emergency expenditures, but given the apparent volume of mortgage equity extraction it’s hard not to conclude that lots of people were just enjoying the extra funds. There’s a weird psychology to all of this. I stand by my earlier take that people didn’t really think they were taking out loans, but were instead essentially selling off a piece of their home to the bank. That’s what “mortgage equity extraction” would really be.

I think it’s important for progressives to shift the dial, relative to these sentiments, a bit away from shadenfreude and back toward the sympathy setting. The missing fact in this narrative is stagnating incomes. Incomes fell from their late-Clinton highs early in the Bush years and though that recession was mild by historical standards, the subsequent recovery was preposterously weak by historical standards. Even years later, incomes hadn’t re-achieved their late-Clinton high point and then we started tumbling into the current downturn. People were, yes, “just enjoying the extra funds” and without really understanding — or wanting to understand — what they were doing. But the policymakers responsible for running the country didn’t raise any warning signs about these trends or even try to initiate a discussion about whether there was any reasonable way to keep things under control. Meanwhile, the broad conservative movement spent a lot of time trying to shout down anyone who worried about rising inequality or stagnant wages by pointing out that the trends looked better if you only examined consumption. In other words, if you ignored the fact that people were maintaining consumption growth by piling on more debt, things looked great! And yet, now somehow things don’t look so great….

Obviously, the mere fact that conservative politicians, hacks, and operatives were egging this trend on didn’t force anyone to accumulate enormous debts. Plenty of people didn’t do so. But the underlying ill here is economic policies that sought to substitute an asset price bubble and innovative credit products for real, broadly-based prosperity.

Into The Breach

The most tangible sign of the credit crunch has been the complete drying out of the so-called “commercial paper” market, wherein companies pass out IOU slips (”unsecured debt”) so that their day-to-day operations aren’t shackled by the ups-and-downs of the cash flow cycle. Under the circumstances, it seems natural for the Fed to consider an unprecedented move to step into the breach and start buying commercial paper in order to get the juices flowing here.

Needless to say, this whole topic is pretty far outside my comfort zone. But I wonder — once the Fed gets into this sort of thing, how easy is it to step back out?

The Collapse in Iceland

Iceland, like various other countries, has recently had to bail out a major bank. And like other countries, it looks like there may be more bank failures on the horizon. But where Iceland differs from other countries is that it’s tiny — fewer than 300,000 people live there — so that even though it’s a prosperous country, it simply doesn’t have very much money in the aggregate. And while its banks aren’t huge, they are quite large relative to the overall size of the Icelandic economy. Consequently, Iceland’s bank nationalization is leaving the country as a whole in need of a bailout.

Financial problems aside, Iceland’s one heck of a nice country. Absolutely beautiful and blessed with abundant reserves of puffins, hydropower, fish, and Bjork. Ultimately, taking over Iceland could be an excellent long-term move for a great power on the rise. Maybe China wants a new colony? After all, the US shut down the Keflavik Naval Air Station last year so it’s a wide open field.

UPDATE: More here from the Observer. Joking aside, the situation is quite serious: “Yesterday people were buying up supplies of olive oil and pasta after a supermarket spokesman announced on Friday night that they had no means of paying the foreign currency advances needed to import more foodstuffs.”

After Legislating

Having gotten its $700 billion worth of authority to buy “troubled” assets, the Treasury Department now needs to figure out what to actually do. One oddity of the debate over the rescue package is that, by necessity, to make a program of this sort work you need to have over a fair amount of discretionary authority to the implementers. But that means there’s an enormous range of things they might actually do and nobody really knows today — or knew earlier this week as we debated the program — what would actually happen if it passed.

Meanwhile, Hank Paulson and the Treasury Department certainly haven’t been the least impressive part of the Bush administration, but his performance has hardly been awe-inspiring.

Banking Bracket

Not sure who made this, but it’s pretty funny:

My guess is that once we get to the Final Four, free market ideology is going to be out of steam and massive socialism will come out on top, boosting along by a tide of bank nationalizations.

Selling the Plan

David Colker and Tom Hamburger have a great reported piece in the Los Angeles Times looking at how Bush, Paulson, and Bernanke screwed up the initial pitch for a rescue plan:

Leaders of some of Washington’s most powerful political interest groups — including business, labor and civil rights organizations — said that instead of starting out by organizing a broad-based coalition to build bipartisan support and mounting a grass-roots campaign to explain the crisis to Main Street, administration and congressional leaders focused on reassuring Wall Street. [...]

AFL-CIO President John Sweeney, for example, was never consulted by the administration, according to labor union officials. Sweeney knows Secretary Paulson and has been called by him in the past. [...]

“That would have been important,” said the lobbyist, who asked not to be identified because making such comments publicly could be bad for business. “Among other things it would provide a great photo op: Bush could have stood there with labor leaders, workers from leading corporations, members of the Black Chamber of Commerce, the Hispanic Chamber of Commerce.”

Last time I posted on this some folks replied that, well, things had reached such a point after the Lehman breakdown that Paulson had to just throw his proposal down on the table. But that seems wrong to me. The markets needed reassuring, but Paulson could have simply announced that he’d decided that a comprehensive solution was needed and that he was calling congressional leaders to spend the weekend meeting with him and Bernanke to discuss a solution. Then other administration folks could have, as the article suggests, called business and labor leaders to explain the situation to them and had them and state and local officials talk to the public about the nature of the problem.

Instead, well, we got what we got — a poorly designed initial plan that was unacceptable to congressional leaders from both parties, silence from non-governmental actors, and a rising public backlash against a mysterious and seemingly under-motivated plan.

More Mark-to-Market

Starting at around minute 40 of this video, Princeton Economist Alan Blinder has an informative discussion of the mark-to-market issue. Let me try to give a written account that’s less flip than what I wrote this morning. The idea of mark-to-market accounting is that when you’re reporting your balance sheet — your assets and your liabilities — you need to report the value of your alleged assets at what you could actually get for them on the market. In a normal highly liquid market, this is easy and non-problematic. But as Blinder says, in an illiquid and non-functioning market, as we currently have for our “troubled” assets, you get into trouble. Specifically, you get these huge spreads between the bid price and the ask price for the assets and no actual sales happening. Blinder’s example is that if the highest bid is $20 and the lowest bid is $60, where do you value the asset? Thus, “there are legitimate problems that need some attention in how you apply mark-to-market accounting when markets aren’t functioning.”

He continues, however, with “having said that, I know a wrong answer, which is to put it in at face value.” And that’s what proponents (mostly on the right, but also some on the left) of ending mark-to-market want to do. They want to say that you can value your assets not at what you could sell them for, but at what you paid for them. Blinder returns the example of the $20/$60 bid/ask spread and notes that “I’m pretty sure $100 is the wrong answer.” And yet this is the essence of the proposal — take the fact that the assets are hard to value, and use that as an excuse to unambiguously overvalue them. Mark-to-market, Blinder concludes, is “the worst form of accounting until you start thinking about the alternatives.” For obvious reasons, though, this switch has substantial support in some sectors of the finance community and also appeals to some in congress as a “free” way to “solve” the problem.

No Bonds For You

I think this constitutes bona fide evidence that there’s a credit crisis in this country: “Cities, states and other local governments have been effectively shut out of the bond markets for the last two weeks, raising the cost of day-to-day operations, threatening longer-term projects and dampening a broad source of jobs and stability at a time when other parts of the economy are weakening.”

This kind of thing is making me increasingly baffled by the manner in which this plan was initially unveiled. If ten days ago statements from utterly or partially discredited Bush administration officials had been bolstered by concrete examples of popular mayors and governors talking about this stuff to their constituents, you might have been able to stem the initial tide of popular anger that derailed the legislative process. Since when has the Bush White House been so uncreative about selling their legislative initiatives to the public?

The Self-Destructing GOP

This has been implicit in what a lot of folks have said, but it’s worth observing that the congressional conservatives who spiked the bailout deal yesterday have, among other things, dealt a devastating blow to their own party’s electoral prospects. Not only does John McCain look foolish in a news cycle sense, but economic dislocation plays strongly in the Democrats’ favor at both the presidential and the congressional levels. They would never say so in public, of course, but serious economic problems are the best shot folks like Jeff Merkley, Kay Hagin, Al Franken, and Ronnie Musgrove have. Over the summer, the prospects for a huge Democratic Senate sweep started looking bad, but if things get worse the better those odds look. I’m less familiar with the House situation, but this is like shooting Chris Shays in the back of the head.

Meanwhile, the GOP’s decision to spend the past 24 hours fighting a spin war against the Democrats on cable is bizarre. It’s an extension of John McCain’s preference for winning the news cycle over winning the election. But good though the right-wing spinmeisters may be, you can’t un-spin the vote count — it was a Republican administration that mislaunched the rescue package and it was congressional Republicans that killed the modified package. What the GOP leaders need to do is convince enough of their members to change positions, as quickly as possible, so as to minimize the amount of time this story dominates the news and to minimize the economic fallout. That’s not just the right thing to do it’s in their self-interest.

What Is To Be Done?

Michael Ettlinger talks about what happened yesterday and what the best way to move forward would be:

Tell your friends.

Blaming Nancy

Over at ThinkProgress they’ve compiled a neat video of conservatives backing off the ludicrous claim that Nancy Pelosi’s speech somehow forced people to vote “no” on the bailout:

Good for them.

Brooks: House ‘Wingers Are Destroying the GOP

David Brooks is not a happy camper:

House Republicans led the way and will get most of the blame. It has been interesting to watch them on their single-minded mission to destroy the Republican Party. Not long ago, they led an anti-immigration crusade that drove away Hispanic support. Then, too, they listened to the loudest and angriest voices in their party, oblivious to the complicated anxieties that lurk in most American minds.

Now they have once again confused talk radio with reality. If this economy slides, they will go down in history as the Smoot-Hawleys of the 21st century. With this vote, they’ve taken responsibility for this economy, and they will be held accountable. The short-term blows will fall on John McCain, the long-term stress on the existence of the G.O.P. as we know it.

This is noteworthy, though I think a little naive of Brooks. The House conservatives who sank the bailout didn’t do so because they were listening to loud and angry voices. They sank the plan by accident. They were trying to double-cross the Democrats. First, they wrung lots of concessions out of Democrats at the negotiating table as the price for delivering 80 votes. Then, by not delivering 80 votes and forcing Pelosi to pass the bill as a partisan Democratic bill, they were going to wage a demagogic anti-bailout campaign. But Pelosi refused to be played for a sucker and so the conservative inadvertently sank a bill that, all evidence suggests, they actually wanted to pass. They just wanted to vote “no” on it for short-term political gain.

Expertise Matters

I think Chris Bowers makes a lot of good points here about the offensive, unwarranted, counterproductive tone of sneering contempt and bullying that bailout proponents have had for opponents and the American public. But he follows that up with a very bad point:

Besides, if there is one subject where everyone in America is something of an expert, it is the economy. Everyone is forced to live in it, everyday, and so we all have on the job training and experience in how it works.

That’s just bullshit. We all live our lives subject to the laws of physics, but that doesn’t mean that we all pick up intuitive understanding of how physics operates. In fact, just the reverse. Our personal experience of the operation of gravity, air resistance, friction, etc. is deeply misleading and leads to all kinds of wrong folk-physics notions about heavier objects falling faster than light ones. Similarly, most people in their personal lives aren’t aware of making any dramatic decisions based on small changes in interest rates. Therefore, they may conclude that small across-the-board changes in interest rates couldn’t possibly have dramatic impact on their lives. And yet, anyone who thinks that is wrong. But to see that that’s wrong, you need to acquire some expertise in the subject.

I think some populism is very much a good thing, but this kind of “who needs experts?” thinking is, I think, best left to the conservatives who’ve managed to run the country into the ground by using it as a guiding philosophy.

In Case You Were Wondering

I’ve been a bit confused as to how the failure of a bill supported by Nancy Pelosi, and Harry Reid, and Barack Obama, and a majority of House Democrats, and a majority of Senate Democrats but opposed by a majority of House Republicans could possibly be laid at the feet of Pelosi, but if you’re interested in exploring this alternate universe in which Pelosi controls the behavior of House Republicans Megan McArdle “explains” the whole thing. It’s strange that such delicate souls are in the rough-and-tumble business of electoral politics.

The Paulson Crisis

One issue that I don’t think has been adequately explored yet is the extent to which our current predicament is attributable to Hank Paulson’s mismanagement of the situation ten days ago. After underreacting to problems at Lehman Brothers and bringing us close to brink, Paulson abruptly reversed months of (false) reassurance that everything was fine and decided that dramatic action was needed. The smart thing to do would have been to privately alert key congressional leaders that he thought the ad hoc approach wasn’t sustainable and they and their staffs should expect to spend the weekend in sequestered talks with him and Ben Bernanke to work something out. They could have announced to the public that bipartisan discussions were underway to think out a comprehensive approach to problems in the financial system. I bet something could have been worked out.

Instead, Paulson unilaterally unveiled a plan that, in its initial form, was completely unacceptable to legislative leaders in either party. And then, in a misguided effort to ramrod a bad bill through congress, he did the equivalent of strapping a bomb to the entire US economy by dramatically announcing that the entire banking system was on the verge of imminent failure.

Naturally, this had the effect of taking whatever real problems were growing and making them much more severe by creating a sense of panic. It did not, however, have the effect of transforming an unacceptable plan into an acceptable one. So congressional leaders wound up needing to meet privately and negotiate with Paulson anyway. Which is what he should have done in the first place. But in the interim, justified criticism of Paulson’s initial plan helped poison opinion against the (better) bill that eventually emerged. Had Paulson proceeded in a more reasonable manner from the get-go, I think it’s very possible that we wouldn’t be in this situation.