The Paulson Bailout

Professor Tabarrok:

 

I read your very interesting article/blog post entitled “What Credit Crunch” a little over a week ago.  I found it very persuasive.  Since then, I’ve been sending emails, making calls, and writing blog posts that largely contain the following content:

 

            I’ve been skeptical that the credit crunch is all that serious for quite some time because of Federal Reserve data re. loans to businesses and consumers.  And I have been very opposed to the Paulson Plan for this and many other reasons.  Now, admittedly, the freeze in interbank lending (et al) might finally be starting to have some significant impact on the non-financial sectors of the economy.  Assuming that this is true for the sake of argument, and that the government needs to step in (which I have no problem with in theory being a Liberal Democrat), what about low-interest or interest-free loans to the banks and institutions that didn’t invest in mortgage-backed securities?  In other words, if the problem is that there is insufficient credit getting to the “real” economy, the government can use the 700 billion (or some other amount) to extend loans to banks that followed the best practices, and these banks can in turn lend the money to consumers and businesses at more standard rates.  It seems to me that this would more directly address the problem of insufficient credit while at the same time avoiding the moral hazard created by bailing out banks and other firms that overextended or made bad bets.  To paraphrase what Alex Tabarrok, Professor of Political Economy at George Mason University, said – why not increase lending “traffic” over the good bridges (i.e., banks, the intermediaries between lenders and borrowers) rather than trying to rebuild the bridges that have burned down (the banks with the “toxic assets”)?  Some economists are suggesting something along these lines.  Do you have any thoughts about this?

 

As you can see, I found your arguments very persuasive.  What I’m curious about is why so few people are talking about alternative options to purchasing the “toxic assets.”  Have you been in touch with people?  I’ve seen other economists making points similar to your’s.  Is this just a case of Paulson and Bernake throwing out an idea and sticking with it despite arguments that there are better approaches?

 

If you have any thoughts, and have time to share them, I’d love to hear what you think.

 

Josh