Best blog post o’ the month

The Compulsive Theorist has written a truly excellent post on bank bailouts (ht Mark Thoma). I’ll excerpt a bit below, but do read the whole thing:

I sympathize with the point of view which says that the political window of opportunity is narrow and the need for action urgent, so let’s accept the bailout plan for now, and deal with… wider issues later on. But the very fact that political momentum is limited means that if these wider changes are to be brought about, the process has to begin in earnest at once. Does anyone seriously believe that in a years time, if following massive government support the banks are stable — or can be made to appear stable — there will be any political will to break up very large institutions, or any real change to underlying norms in the financial sector?

However, absent these deeper changes, it is entirely possible that we will see a replay of the crisis — but on a larger scale — in a few years time. Naturally, one cannot say with certainty that such a cataclysm (and if it were much larger than the current crisis, it really would be a cataclysm) will occur. But if it does, the resulting costs will be huge. Martin Wolf has written persuasively about the costs of major economic dislocation. Net of unemployment, political instability and even wars, the human costs of a sequel could dwarf even the current crisis. Then, the choice in the present between the “bailout” and “restructuring” plans hinges on whether expected cost (in the broadest sense), conditioned on the “bailout” strategy is higher than expected cost conditioned on “restructuring”. One could formalize this argument as a decision problem, but it comes down to a judgement call on the relative probability of such a cataclysm under the two strategies and the magnitude of the dislocation. My feeling, admittedly subjective, is that the gloomy cataclysm scenario is substantially more likely under the “bailout” than “restructuring”, and that the costs would be immense.

This case can be put very simply: if we do not use current political momentum to fundamentally reform a system which has shown itself to be unstable and even dangerous, a second opportunity may come at a very high price. And this is not a gamble I wish to see our leaders make.


5 Responses to “Best blog post o’ the month”

  1. Vince writes:

    In other, more cynical, words, never let a perfectly good crisis go to waste. To mix metaphors, strike while you have ’em by the short and curlies. This is a damn’ cynical view of politics, that only popular legislation can get air time, regardless of how right it is.

  2. anon writes:

    “The problem with the Geithner plan is that even it works in terms of stabilizing the economy in the short-term, it does relatively little (the uncharitable would say almost nothing) to correct either incentives or system design.”

    What ever happened to the adult approach of solving problems in stages? Populist, compulsive bankruptcy lynchings are consistent with the childish mores that created the problem in the first place. The Obama administration may be wiser than you give them credit for.

  3. RueTheDay writes:

    My biggest fear is that we never get past the “prop up the system at all costs” stage. This crisis has been going on for what, almost two years now? Yet the focus is still on short term rescues and bailouts. I fear that we’re never going to get any sort of meaningful reform – the re-imposition of Glass-Steagall or some other mechanism for building firewalls between the key components of the financial system, implementation of capital adequacy standards for systemically important non-banks, restructuring of incentive comp to be more compatible with long term stability and growth as opposed to short term leveraged gambling, and rational oversight of the derivatives markets. At best, some existing institution like the Fed will be designated “systemic risk regulator” (whatever that means) and some phoney executive comp restrictions that are easily gamed.

  4. Nonsense. My plan is very simple. Repeal the Federal Reserve Act. Repeal the legal tender laws. Let the TBTF banks file bankruptcy. Return to a real gold standard. At what price? At least $10,000 an ounce. Maybe higher.

  5. Via Clayton Christensen, a Harvard Business School professor who originated the canonical Model of Disruptive Innovation: “[Industry] regulations ultimately change *in reaction to* the innovators’ success in those markets” [1].

    Enter this Facebook group:

    NYC’s $3M Angel Fund: Invest in start-ups that, en route to becoming a bank, provide people with new and improved ways to customize education, and to showcase and earn money from expertise (i.e., ways to become (more) creditworthy).

    Adapted from a biz plan praised by analysts at Microsoft, and top VC.

    [1] See page 386 of The Innovator’s Prescription, a 2009 book by Christensen et al.