In the 1990s, American economists roamed the world preaching the virtues of fiscal restraint, the rule of law, free trade, and privatization. Today, those four policy pillars, once known as the Washington Consensus, are abandoned in the city that gave that consensus its name. These policies were never commandments from Mount Sinai, but they are important ingredients of long-run economic success. In a recession, putting today's needs ahead of tomorrow's prosperity is understandable, but even in bleak times, doing too much can be worse than doing too little.....
For our children to face this debt, they will need free trade, private ownership, and respect for private property. Eliminating fiscal restraint during a recession is understandable. Eliminating all four pillars of sound economic policy imposes too much of a cost on tomorrow for too little benefit today. - Harvard Professor Edward L. Glaeser in th Boston Globe.
Then there is a new academic paper by Harvard's Joshua Coval and Erik Stafford and Princeton's Jakub Jurek where they state among other things that,
* Many banks are now insolvent. "...many major US banks are now legitimately insolvent. This insolvency can no longer be viewed as an artifact of bank assets being marked to artificially depressed prices coming out of an illiquid market. It means that bank assets are being fairly priced at valuations that sum to less than bank liabilities."
* Supporting markets in toxic assets has no purpose other than transfering money from taxpayers to banks. "...any taxpayer dollars allocated to supporting these markets will simply transfer wealth to the current owners of these securities."
* We're making it worse. "...policies that attempt to prevent a widespread mark-down in the value of credit-sensitive assets are likely to only delay – and perhaps even worsen – the day of reckoning."
In short, the government cannot save the banks by improving liquidity or changing mark to market rules because the problem isn't illiquidity or accounting. The problem is that highly leveraged financial firms own assets that are worth far less than they thought they would be, and the firms are insolvent as a result. This is why the latest bailout plans secretly give huge subsidies to banks--because the only way to keep the insolvent zombies afloat is to transfer billions of dollars to banks, bank stockholders, and bank creditors. The alternative--allowing the insolvent banks to fail, seizing the assets, wiping our shareholders, giving bond holders a serious haircut--is still not on the official agenda.
And lastly we have Paul Krugman who in his NY Times column and his blog, Conscience of a Liberal, regularly criticizes the Obamaites for trying to prop up a financial system that he regards as essentially a dead man walking.
What is interesting, and frightening, about the above examples is that they are all critiques from the left. Ivy League professors from the northeast can't be accused of simply Obama-bashing. In fact many of them, Krugman in particular, were very pro-Obama during the campaign season. Therefore their harsh words on the economy and the president's handling of it are quite serious indeed.
Now what is a layman to make of all this? Over the past six months, the U.S. has spent trillions of dollars to help stabilize companies and restart stalled credit markets. It's now the proud co-owner of some of the biggest American firms, such as auto companies, banks and an insurance giant. Now what if it doesn't work?
While as a conservative I would love to stand up and say "I told you so," I am more concerned that the system as a whole will become so broken we can't fix it.
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