In yesterday's post
I asked Public Offering visitors the same question I asked my Modern Political Economy students: Should the federal government intervene in the current crisis or simply let the market work its painful way out?
Many of my students responded, and the blog editor chose a couple to publish.
From Sean Murtagh ’08: More...
Needless to say, the current debate over a government-backed housing bailout is a thorny subject, with strong arguments on either side. While I personally am not in favor of excessive government intervention in the functioning of markets, I believe there are rare times when such intervention is necessary not only to restore the functioning of these markets but also to promote the overall health of the economy.
In today’s environment I fear that such an intervention may be necessary, as the albatross around the economy’s neck that is the residential housing market seems to be spreading dangerously into other important markets, such as the commercial real estate and leveraged-loan markets.
If this ripple effect shuts down these and perhaps other credit markets, I believe the consequences for the economy would be disastrous: a large portion of economic activity would grind to a standstill due to the resulting scarcity of credit, a condition that as a result of expectations could persist for a long period of time.
The real issues to be analyzed are whether or not this credit shutdown is likely to happen, and if it does occur, how long is it likely to persist, questions that are difficult at best to answer.
If, after a thorough analysis, the answer to either question suggests a mild interruption either in terms of scope or time, my recommendation would be to allow the market itself to sort out the current housing crisis. As long as credit does not totally dry up, at some price home buyers will once again enter the market eventually restoring a new equilibrium.
If, however, best estimates are for a protracted disruption in the overall credit markets, I believe government intervention in the housing market — provided it is done in as minimalist and expedient a way as possible — is sensible despite the moral hazard and other compelling arguments against such an intervention.
While I am certainly not in favor of bailing out the speculator or any of the scores of individuals who engaged in blatant fraud during the recent housing boom, I am in favor of seeing the economy as a whole remain well-functioning. I don’t believe we should allow the overall economy to suffer unreasonably just to teach certain individuals a lesson.
From Erik Diehn ’08:
I’m not sure that letting an institution like Citibank go bust is the best answer to a financial crisis — while the investors, managers and other parties who turned a blind eye to lax CDO repackaging and lending would certainly get their comeuppance, having a major financial institution melt down would result in all sorts of damage to the various completely innocent parties who hold accounts, loans, etc. in Citi’s diverse businesses. I think, in fact, that Aaron [fellow MPE student commenter] is right on when he points out that some relief is needed to keep the wheels of credit turning so that businesses and individuals can continue to borrow to expand their economic undertakings.
What concerns me more than the specific moral hazard created by bailing out bad mortgages is the impact this kind of intervention might have on the millions of nondefaulting but nevertheless indebted Americans who borrowed heavily against nonproductive assets (houses) to fuel a continuing consumption binge (cars, flat-screen TVs, etc.). We have been living through at least 15 years of continuous asset-price inflation; will a government intervention in this deflation — whether through buying up mortgages or reducing interest rates — just create more of the same?
It seems to me that ultimately, there's no quick fix for the fact that in the long run we’re going to have pay for these bubbles one way or another. My hope is that any sort of government proscribed remedy (a) lessens the pain of this readjustment so that we perhaps have a longer but less severe period of austerity and rebuilding rather than a shorter but more painful shock and (b) provides regulatory tweaks that shift incentives so that the chances of another bubble are reduced.
Of course, some people think that bubbles are inevitable and more or less a required part of the modern U.S. economy — see “The Next Bubble” and related postings from the February 2008 edition of Harper’s Magazine for a prime example of this theory. I’m not sure I subscribe to a view that extreme, but I do think that as a country we have developed an awful lot of dependence on speculative growth and create a lot less fundamental value than we used to.