This Time, Uncle Sam Has Got Our Back
By Laurence J. Kotlikoff and Perry Mehrling
The Washington Post
Thursday, October 9, 2008; Page A21
Global markets have not been reassured by the
coordinated interest rate cuts of several central
banks or by recent congressional action, but they
should be. Our bet is that financial markets will
return to normal in short order and that the U.S.
economy will squeak by with a moderate recession.
Recapitalizing the banks and working out mortgages
will take time, but the financial system will not
collapse -- the government won't let it.
The markets, of course, seem to be factoring in some
probability of collapse. Why is this wrong?
For starters, the biggest subprime mortgage gamblers
have already failed, been nationalized or been married
off, shotgun-style, to banks run by grown-ups. Yes,
lots of small shoes may still drop, but the Paulson
"buy-up" bill, and, ultimately, the Fed's ability to
print money, provides the Treasury and Federal Reserve
all the tools they need. The media don't seem to have
noticed, but Section 113 of the bill authorizes
government capital infusions into the banking system
as necessary -- something the British government is
now doing and the Swedish government successfully did
in the recent past. That means any bank with a viable
business will not be allowed to fail simply because it
is temporarily undercapitalized.
Second, Uncle Sam (a.k.a. Treasury Secretary Hank
Paulson and Fed Chairman Ben Bernanke) is doing
precisely what's needed to avoid the mistakes of the
1930s. With credit markets drying up, he's turning on
the faucet by recycling our panic dollars back into
the financial market.
The government is taking in our money (in exchange for
Treasury bills) and using it to make mortgages and buy
up the assets we're too scared to hold. It's doing
this via the Treasury, the Fed, the Federal Deposit
Insurance Corp., the Federal Housing Administration,
the Federal Home Loan Bank, Fannie Mae, Freddie Mac
and other appendages. It's starting to lend directly
to large and small businesses whose usual sources of
credit have become unavailable.
In short, Uncle Sam is becoming our new bank. He has
also become our new insurance company with his
effective purchase of the world's largest insurer --
AIG.
In the 1930s, nobody in the private sector could
borrow, raise equity or sell insurance because
everyone lost trust in everyone else. Uncle Sam stood
on the sidelines and marveled at the chaos. But today
Uncle Sam is saying, "Listen, if you households and
firms are too scared to invest in each other or sell
each other insurance, give us your money, and we'll do
it for you. We'll pay you a sure return on the
Treasuries and, if our investments and insurance sales
do well, you'll benefit by paying lower taxes."
This may sound like socialism or state capitalism, but
it's simply rearranging the financial furniture. As
Americans have freaked out, Uncle Sam has stepped up.
He'll continue doing so until we realize the sky is
not falling. The $700 billion rescue authorizes the
federal government to keep doing what it has been
doing for the past year to the tune of $400 billion --
buying distressed assets at bargain-basement prices
and selling insurance at high premiums. If all works
out, Uncle Sam will make a killing. This would be
great, given our government's real problem -- paying
the long-term Social Security and medical costs of
retiring baby boomers.
Point three is clear: This financial chaos has ruined
our sleep but left our physical and human capital
unscathed. We have the same productive capacity today
we had a year ago. And if our capital hasn't changed,
we've suffered no overall capital loss.
This means that our accounting, which has focused on
financial losses, is missing lots of offsetting
financial gains. The offsetting gains are accruing to
current or prospective purchasers of the assets whose
market values have dropped. Asset buyers, whether they
are young people buying their first homes, middle-aged
workers contributing to their 401(k)s or billionaires
such as Warren Buffett buying financial firms, can now
acquire homes and stocks (claims to the same capital
inside the companies) at a roughly one-third discount
from a year ago. That's great for them, and lousy for
the rest of us, but not a net economic tragedy.
The economic tragedy comes if we get hypnotized by the
bad news, ignore the good news, fight about things
we're already doing (e.g., having Uncle Sam buy and
insure troubled assets) and pull our economic heads
inside our shells. We Americans have lots of moxie.
What we need is a strong pep talk and absolute
assurance that credit will continue to flow, that
insurance policies will continue to be honored, and
that Uncle Sam is willing and able to invest directly
in the private economy on our behalf.
So after scaring us half to death, this would be a
good time for our other uncles -- Hank and Ben -- to
make clear that we're heading for a safe landing and
that there is no way in hell they will let this
economy go down the tubes.
Laurence J. Kotlikoff, a professor of economics at
Boston University, is co-author of "Spend 'Til the
End." Perry Mehrling is a professor of economics at
Columbia University's Barnard College and author of
"Fischer Black and the Revolutionary Idea of Finance."
By Laurence J. Kotlikoff and Perry Mehrling
The Washington Post
Thursday, October 9, 2008; Page A21
Global markets have not been reassured by the
coordinated interest rate cuts of several central
banks or by recent congressional action, but they
should be. Our bet is that financial markets will
return to normal in short order and that the U.S.
economy will squeak by with a moderate recession.
Recapitalizing the banks and working out mortgages
will take time, but the financial system will not
collapse -- the government won't let it.
The markets, of course, seem to be factoring in some
probability of collapse. Why is this wrong?
For starters, the biggest subprime mortgage gamblers
have already failed, been nationalized or been married
off, shotgun-style, to banks run by grown-ups. Yes,
lots of small shoes may still drop, but the Paulson
"buy-up" bill, and, ultimately, the Fed's ability to
print money, provides the Treasury and Federal Reserve
all the tools they need. The media don't seem to have
noticed, but Section 113 of the bill authorizes
government capital infusions into the banking system
as necessary -- something the British government is
now doing and the Swedish government successfully did
in the recent past. That means any bank with a viable
business will not be allowed to fail simply because it
is temporarily undercapitalized.
Second, Uncle Sam (a.k.a. Treasury Secretary Hank
Paulson and Fed Chairman Ben Bernanke) is doing
precisely what's needed to avoid the mistakes of the
1930s. With credit markets drying up, he's turning on
the faucet by recycling our panic dollars back into
the financial market.
The government is taking in our money (in exchange for
Treasury bills) and using it to make mortgages and buy
up the assets we're too scared to hold. It's doing
this via the Treasury, the Fed, the Federal Deposit
Insurance Corp., the Federal Housing Administration,
the Federal Home Loan Bank, Fannie Mae, Freddie Mac
and other appendages. It's starting to lend directly
to large and small businesses whose usual sources of
credit have become unavailable.
In short, Uncle Sam is becoming our new bank. He has
also become our new insurance company with his
effective purchase of the world's largest insurer --
AIG.
In the 1930s, nobody in the private sector could
borrow, raise equity or sell insurance because
everyone lost trust in everyone else. Uncle Sam stood
on the sidelines and marveled at the chaos. But today
Uncle Sam is saying, "Listen, if you households and
firms are too scared to invest in each other or sell
each other insurance, give us your money, and we'll do
it for you. We'll pay you a sure return on the
Treasuries and, if our investments and insurance sales
do well, you'll benefit by paying lower taxes."
This may sound like socialism or state capitalism, but
it's simply rearranging the financial furniture. As
Americans have freaked out, Uncle Sam has stepped up.
He'll continue doing so until we realize the sky is
not falling. The $700 billion rescue authorizes the
federal government to keep doing what it has been
doing for the past year to the tune of $400 billion --
buying distressed assets at bargain-basement prices
and selling insurance at high premiums. If all works
out, Uncle Sam will make a killing. This would be
great, given our government's real problem -- paying
the long-term Social Security and medical costs of
retiring baby boomers.
Point three is clear: This financial chaos has ruined
our sleep but left our physical and human capital
unscathed. We have the same productive capacity today
we had a year ago. And if our capital hasn't changed,
we've suffered no overall capital loss.
This means that our accounting, which has focused on
financial losses, is missing lots of offsetting
financial gains. The offsetting gains are accruing to
current or prospective purchasers of the assets whose
market values have dropped. Asset buyers, whether they
are young people buying their first homes, middle-aged
workers contributing to their 401(k)s or billionaires
such as Warren Buffett buying financial firms, can now
acquire homes and stocks (claims to the same capital
inside the companies) at a roughly one-third discount
from a year ago. That's great for them, and lousy for
the rest of us, but not a net economic tragedy.
The economic tragedy comes if we get hypnotized by the
bad news, ignore the good news, fight about things
we're already doing (e.g., having Uncle Sam buy and
insure troubled assets) and pull our economic heads
inside our shells. We Americans have lots of moxie.
What we need is a strong pep talk and absolute
assurance that credit will continue to flow, that
insurance policies will continue to be honored, and
that Uncle Sam is willing and able to invest directly
in the private economy on our behalf.
So after scaring us half to death, this would be a
good time for our other uncles -- Hank and Ben -- to
make clear that we're heading for a safe landing and
that there is no way in hell they will let this
economy go down the tubes.
Laurence J. Kotlikoff, a professor of economics at
Boston University, is co-author of "Spend 'Til the
End." Perry Mehrling is a professor of economics at
Columbia University's Barnard College and author of
"Fischer Black and the Revolutionary Idea of Finance."
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