A $700‐Billion‐Dollar “TARP” Won’t Cover Over Economic Realities
I've posted a copy of the proposed bailout legislation online in html format, which is easier to read, copy, and paste. Considering its size and significance, I urge you to review it and share it with others.
We have several experts on the bailout at Cato, and our media producer Caleb Brown has ably drawn them out. Give a listen to his podcasts with Bill Niskanen, Jagadeesh Gokhale, Jim Dorn, Arnold Kling, Gerald P. O'Driscoll, and John Samples. [all mp3 format]
There are a couple of elements of the legislation where I might add some insight, so here goes.
Congressional Oversight? Nope. $700 Billion Spent
The bill made available Sunday devotes a good deal of verbiage to oversight of the proposed $700 billion bailout. But it doesn't do anything to prevent that money being spent.
The major impediment to blowing through all the money is in Section 115, entitled "Graduated Authorization to Purchase." It would immediately grant the Treasury Secretary authority to spend $250 billion. At any time, the President could send a certification to Congress and the spending authority would rise $100 billion more. After that certification, the President would have only to submit a plan to spend yet more and the Secretary's authority would rise to the full $700 billion.
Only if Congress introduced and passed legislation to stop further spending would it be capped at $350 billion. Congress would almost certainly not pass such legislation, and even if it did the President could veto it, requiring an impossible-to-reach supermajority in both houses to stop the spending.
Passage of the "Emergency Economic Stabilization Act of 2008" would cause $700 billion to be spent - gone - just like earlier proposals. There is no effective limit on spending in this bill.
Yes, there are a number of oversight mechanisms, and no grant of unreviewable discretion as appeared in a ham-handed earlier proposal. These improvements are all about how the barn door will be closed once the $700 billion is gone.
Covering Over Economic Reality With a "TARP"?
The central feature of the bill is the creation of "TARP," the "Troubled Asset Relief Program," in Section 101. The TARP would exist to "purchase, and to make and fund commitments to purchase, troubled assets from any financial institution, on such terms and conditions as are determined by the Secretary . . . ."
We know that mostly these are going to be mortgage-backed securities of the type issued by Fannie Mae and Freddie Mac. Fran and Fred issued these - and financial institutions bought them - with abandon because of the implicit (and now realized) government backing Fannie and Freddie enjoyed.
Currently, these securities have no value - "worthless paper," everyone says. This is not because they are valueless, but because there is enough uncertainty about their value that nobody knows how to price them, so nobody is currently buying.
The idea behind the bailout plan, it seems, is to remake a market for this paper by having the federal government buy it. But it won't work. And here's why.
(N.B., I'm a lawyer and strictly an amateur with economics. There are weaknesses and disanalogies in what you're about to read, but this is the best non-economic "Man on the Clapham Omnibus" explanation I've been able to assemble so far.)
Imagine there was a burgeoning trade in beach sand. Because of all the profits others had made on buying and selling beach sand, people came in to the beach sand market and bid up the price, hoping to get their cut of the money to be made.
Then one day, someone pointed out to all the beach sand traders that there's beach sand all over the place at the beach. There's so much beach sand that it can't possibly be worth what people are paying.
Immediately, the market for beach sand would stop functioning, as everyone who held beach sand would not be able to find someone who would buy it at a price they could accept.
What's the solution to this problem? A downward repricing of beach sand.
There is no alternative but for the market to reform around lower-priced beach sand.
Now, what if the government came in and bought $700 billion dollars worth of beach sand? Current holders of beach sand would get a tremendous windfall, and the government would get a lot of beach sand, but the market for beach sand would not be restored. It would only return when beach sand was again priced at a value that people believed was right. Taxpayers would be out $700 billion and the market for beach sand would be no stronger than before.
Now, there are disanalogies between what I've said and the proposed financial services bailout. Unlike beach sand, which is essentially infinite and thus very cheap, mortgage-backed securities actually do have some value. The market just has to discover what it is.
There are good buys right now, and some of the financial services firms that over-committed to mortgage-backed securities and other precarious financial instruments are good buys for smarter players too. These securities and the companies that held them need to be repriced, and there's nothing the government can do to change that - or control their prices.
Another weakness in my story is that it omits the other roles that beach sand-traders might have. The financial services firms that got hung up on mortgage-backed securities do lots of other lending that lubricates our economy, and they might have a rough time doing it now. Say beach-sand traders are also integral to the glass industry - we're looking at glass shortages because of the collapse in the sand market. But we had better face that reality rather than trying to avoid it with bigger, more audacious manipulations of economic value than we saw in Fannie Mae and Freddie Mac.
Government attempts to support the prices of mortgage-backed securities, of the housing stock, or of our country's financial services firms will almost certainly end in disaster.
There is no putting a "TARP" over these economic realities, and there is nothing better we can do than to get on with letting the losers lose. No bailout.
