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Open Letter on the Bailout

September 23, 2008

To the Speaker of the House of Representatives and the President pro tempore of the Senate:

As economists, we want to express to Congress our great concern for the plan proposed by Treasury Secretary Paulson to deal with the financial crisis. We are well aware of the difficulty of the current financial situation and we agree with the need for bold action to ensure that the financial system continues to function. We see three fatal pitfalls in the currently proposed plan:

1) Its fairness. The plan is a subsidy to investors at taxpayers’ expense. Investors who took risks to earn profits must also bear the losses. Not every business failure carries systemic risk. The government can ensure a well-functioning financial industry, able to make new loans to creditworthy borrowers, without bailing out particular investors and institutions whose choices proved unwise.

2) Its ambiguity. Neither the mission of the new agency nor its oversight are clear. If taxpayers are to buy illiquid and opaque assets from troubled sellers, the terms, occasions, and methods of such purchases must be crystal clear ahead of time and carefully monitored afterwards.

3) Its long-term effects. If the plan is enacted, its effects will be with us for a generation. For all their recent troubles, Americas dynamic and innovative private capital markets have brought the nation unparalleled prosperity. Fundamentally weakening those markets in order to calm short-run disruptions is desperately short-sighted.

For these reasons we ask Congress not to rush, to hold appropriate hearings, and to carefully consider the right course of action, and to wisely determine the future of the financial industry and the U.S. economy for years to come.

Signed

Acemoglu Daron (Massachussets Institute of Technology)
Adler Michael (Columbia University)
Admati Anat R. (Stanford University)
Alvarez Fernando (University of Chicago)
Andersen Torben (Northwestern University)
Beim David (Columbia University)
Berk Jonathan (Stanford University)
Bisin Alberto (New York University)
Boldrin Michele (Washington University)
Buera Francisco J.(UCLA)
Cassar Gavin (University of Pennsylvania)
Chaney Thomas (University of Chicago)
Chauvin Keith W. (University of Kansas)
Chintagunta Pradeep K. (University of Chicago)
Christiano Lawrence J. (Northwestern University)
Cochrane John (University of Chicago)
Coleman John (Duke University)
Constantinides George M. (University of Chicago)
Crain Robert (UC Berkeley)
De Marzo Peter (Stanford University)
Dubé Jean-Pierre H. (University of Chicago)
Edlin Aaron (UC Berkeley)
Ely Jeffrey (Northwestern University)
Faulhaber Gerald (University of Pennsylvania)
Fox Jeremy T. (University of Chicago)
Fuchs William (University of Chicago)
Gao Paul (Notre Dame University)
Garicano Luis (University of Chicago)
Gerakos Joseph J. (University of Chicago)
Gibbs Michael (University of Chicago)
Goettler Ron (University of Chicago)
Goldin Claudia (Harvard University)
Guadalupe Maria (Columbia University)
Hansen Lars (University of Chicago)
Harris Milton (University of Chicago)
Hart Oliver (Harvard University)
Hazlett Thomas W. (George Mason University)
Heaton John (University of Chicago)
Heckman James (University of Chicago – Nobel Laureate)
Henisz, Witold (University of Pennsylvania)
Hertzberg Andrew (Columbia University)
Hite Gailen (Columbia University)
Hitsch Günter J. (University of Chicago)
Hodrick Robert J. (Columbia University)
Hopenhayn Hugo (UCLA)
Hurst Erik (University of Chicago)
Israel Ronen (London Business School)
Jaffee Dwight M. (UC Berkeley)
Jagannathan Ravi (Northwestern University)
Jenter Dirk (Stanford University)
Jones Charles M. (Columbia Business School)
Kaboski Joseph P. (Ohio State University)
Kaplan Ethan (Stockholm University)
Karolyi, Andrew (Ohio State University)
Kashyap Anil (University of Chicago)
Ketkar Suhas L (Vanderbilt University)
Kiesling Lynne (Northwestern University)
Koch Paul (University of Kansas)
Kocherlakota Narayana (University of Minnesota)
Koijen Ralph S.J. (University of Chicago)
Kondo Jiro (Northwestern University)
Korteweg Arthur (Stanford University)
Kortum Samuel (University of Chicago)
Krueger Dirk (University of Pennsylvania)
Lee Lung-fei (Ohio State University)
Leuz Christian (University of Chicago)
Levine David I.(UC Berkeley)
Levine David K.(Washington University)
Linnainmaa Juhani (University of Chicago)
Manski Charles F. (Northwestern University)
Martin Ian (Stanford University)
Mayer Christopher (Columbia University)
McDonald Robert (Northwestern University)
Meadow Scott F. (University of Chicago)
Mian Atif (University of Chicago)
Middlebrook Art (University of Chicago)
Miguel Edward (UC Berkeley)
Miravete Eugenio J. (University of Texas at Austin)
Miron Jeffrey (Harvard University)
Moro Andrea (Vanderbilt University)
Morse Adair (University of Chicago)
Mortimer Julie Holland (Harvard University)
Nevo Aviv (Northwestern University)
Ohanian Lee (UCLA)
Pagliari Joseph (University of Chicago)
Papanikolaou Dimitris (Northwestern University)
Peltzman Sam (University of Chicago)
Perri Fabrizio (University of Minnesota)
Phelan Christopher (University of Minnesota)
Piazzesi Monika (Stanford University)
Piskorski Tomasz (Columbia University)
Reagan Patricia (Ohio State University)
Reich Michael (UC Berkeley)
Reuben Ernesto (Northwestern University)
Roberts Michael (University of Pennsylvania)
Rogers Michele (Northwestern University)
Ruud Paul (Vassar College)
Safford Sean (University of Chicago)
Sandbu Martin E. (University of Pennsylvania)
Sapienza Paola (Northwestern University)
Scharfstein David (Harvard University)
Shang-Jin Wei (Columbia University)
Shimer Robert (University of Chicago)
Siegel Ron (Northwestern University)
Sorensen Morten (Columbia University)
Spiegel Matthew (Yale University)
Stevenson Betsey (University of Pennsylvania)
Stokey Nancy (University of Chicago)
Strahan Philip (Boston College)
Strebulaev Ilya (Stanford University)
Sufi Amir (University of Chicago)
Thompson Tim (Northwestern University)
Tschoegl Adrian E. (University of Pennsylvania)
Uhlig Harald (University of Chicago)
Ulrich, Maxim (Columbia University)
Van Buskirk Andrew (University of Chicago)
Veronesi Pietro (University of Chicago)
Vissing-Jorgensen Annette (Northwestern University)
Weill Pierre-Olivier (UCLA)
Witte Mark (Northwestern University)
Wolfers Justin (University of Pennsylvania)
Zingales Luigi (University of Chicago)

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24 Comments
  1. September 23, 2008 4:39 pm

    I’m by no means an expert in economics, but isn’t the larger story of the financial crisis, the underlying story, something like:

    1. The median wage hasn’t kept up with the median home price, or anything
    else, for 30 years, because the benefits of economic growth have pretty
    much (aside from a brief two or three years in the late 90s) all gone
    to the top of the income scale;

    2. Rather than address the median wage problem by, you know, raising it, the Powers-That-Be instead;

    3. Came up with ever-more-exotic ways to saddle the median worker with ever-more-crushing amount of debt until;

    4. The Median-wage-earner-who-hasn’t-had-a-raise-in-years is finally, in fact and predictably, crushed by his ruinous debt?

    And now we need to bail out Wall-Street, enablers and cheerleaders of the ones who haven’t given their workers a real raise in years, because otherwise they’ll ruin the
    economy? Am I missing something or is that about the size of it??

  2. Jeremy permalink
    September 23, 2008 4:43 pm

    MT, sounds like you get the gist. I don’t think you can raise a ‘Median’ wage by fiat. Have any of the candidates attempted to address the underlying problems of this?

  3. blackadderiv permalink
    September 23, 2008 4:48 pm

    Matt,

    I don’t think that has much to do with it, no.

  4. September 23, 2008 4:52 pm

    Jeremy – Obama’s come closer than McCain, but I haven’t hear anyone on the national political scene really address the stagnant-income issue per se.

  5. September 23, 2008 5:02 pm

    I would sign this.

    I quite like the jist of the Dodd plan– if we must do the bailout (and it is probably necessary to avoid a complete meltdown), then we must impose some clear conditions, including on compensation, dividend restrictions, and a taxpayers stake in equity.

  6. Policraticus permalink*
    September 23, 2008 5:06 pm

    Well, the experts have spoken.

  7. blackadderiv permalink
    September 23, 2008 5:17 pm

    MM,

    Out of curiosity, what is your opinion of the mark-to-market accounting requirements? Were they a significant factor in the collapses we’ve seen so far? Would suspending the rule now do anything to solve the problem? Or is the matter simply another red herring, in your opinion?

  8. S.B. permalink
    September 23, 2008 6:23 pm

    I’m usually skeptical of these kinds of mass letters, but when you’ve got folks like Acemoglu on board, it’s worth taking seriously.

  9. little gal permalink
    September 23, 2008 7:41 pm

    Paulson’s net worth has been estimated at over US$700 million–I suspect he knows what he’s talking about…

  10. Greg permalink
    September 23, 2008 9:21 pm

    Blackladderiv,

    The mark-to-market accounting requirements had nothing to do with the collapse. They simply brought to light a pre-existing problem. It is just as ludicrous to remove these rules as it is to ban short-selling.

  11. September 23, 2008 9:36 pm

    MM, I’m with blackadder… I’ve heard & read some saying that temporarily relaxing the mark-to-market requirements would get money moving in the system again. I have absolutely no idea what these requirements mean (!), but I’m curious about your thoughts.

  12. Greg permalink
    September 23, 2008 9:37 pm

    We don’t have time for Congress to wade through months of testimonies getting caught up in mind-numbing detail.

  13. September 23, 2008 9:44 pm

    FWIW, here’s economist Brian Wesbury’s proposal re: mark-to-market:

    http://www.ftportfolios.com/Commentary/EconomicResearch/2008/9/22/heres_a_plan_to_avoid_a_new_rtc

  14. September 23, 2008 10:58 pm

    Yes, mark-to-market is a problem, but not really because of the accounting standard itself, but because nobody really knows how to price these things. This will be a big problem for the bailout.

    Not having mark-to-market would be even worse, as the system would be even more non-transparent, and covering up losses would surely be easier. The real problem is the interaction of mark-to-market with the Basel II capital adequacy requirements, which fosters procyclical behavior (forcing banks to cut back on lending during bad times, and allowing a boom in good times).

  15. September 24, 2008 8:27 am

    MM, is there a “for Dummies” version of your second paragraph? :-)

    More seriously, can you recommend any good primers on this stuff?

    And while we’re at it, what do you think about Sowell’s two-volume intro to economics?

  16. September 24, 2008 8:30 am

    Hey! I have an idea. Let the stock market (DOW) drop to 7500 and loose 30 trillion of market value and all will be good again.

  17. Greg permalink
    September 24, 2008 8:54 am

    Chris,

    It would be better for you to read a bond book by Fabozzi than any economic book.

  18. September 24, 2008 9:07 am

    Chris,

    Searching for a “for dummies” explanation myself yesterday, items I found most helpful included this summary of the crisis from the Freakonomics blog:

    http://freakonomics.blogs.nytimes.com/2008/09/18/diamond-and-kashyap-on-the-recent-financial-upheavals/

    Also worth looking at are Megan McArdle’s posts on the meltdown:

    http://meganmcardle.theatlantic.com/

  19. September 24, 2008 9:11 am

    Thanks Greg! My question was tangential to this whole issue… the discussion reminded me of my occasional interest in reading a good intro to econ.

  20. Zak permalink
    September 24, 2008 9:35 am

    THe Economist is also skeptical that there’s a problem with mark to market, arguing that it’s just honest reporting – the capital requirements and risk management issues implied with it aren’t within the scope of accounting and shouldn’t be managed through accounting changes. They seem to agree with MM about counter-cyclical capital requirements, referring to Spain’s regulations which have prevented its banks from having major problems, despite its impending recession and housing price drop.

  21. blackadderiv permalink
    September 24, 2008 9:44 am

    It’s not clear to me why the Dodd plan is preferable to Paulson’s proposal. If this account of the plan is accurate, it would give even more power to the Treasury Secretary than would Paulson’s plan.

  22. September 25, 2008 12:37 pm

    MM, thoughts on Sowell? Alternative recommendations?

  23. blackadderiv permalink
    September 25, 2008 2:55 pm

    Chris,

    I haven’t read Sowell’s Basic Economics, though I’ve read some of Sowell’s other books and found them to be quite good. Here is a review of the book by famed “radical economist” Herb Gintis:

    Sowell’s book, Basic Economics, comes pretty close to being a neutral exposition of what economists know about running the economy. There is no statement of fact, no statement of economic principle in this book with which I disagree, even though my background is from the Left, and I have never voted for a Republican in my life, and Sowell is the arch-conservative guru of Hoover Institution fame.

    Gintis has some criticisms, of course, mainly dealing with normative issues and a “good guys/bad guys” mentality in the presentation of conflicts between the market and the state, but overall I’d say he’s a fan.

  24. September 25, 2008 10:45 pm

    Thanks, BA!

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