Bank runs can be contagious; partly that’s for psychological reasons, partly because banks tend to invest in similar assets, so one bank’s fire sale depresses another bank’s net worth.
So now we have a bank crisis. Is it the result of fundamentally bad investment, or is it because of a self-fulfilling panic?
If you think it’s just a panic, then the government can pull a magic trick: by stepping in to buy the assets banks are selling, it can make banks look solvent again, and end the run. Yippee! And sometimes that really does work.
But if you think that the banks really, really have made lousy investments, this won’t work at all; it will simply be a waste of taxpayer money. To keep the banks operating, you need to provide a real backstop — you need to guarantee their debts, and seize ownership of those banks that don’t have enough assets to cover their debts; that’s the Swedish solution, it’s what we eventually did with our own S&Ls.
As Krugman (and a few others) points out, the government since the Henry Paulson plan proposed last Fall has been treating this banking crisis as a psychological problem, when in fact it’s a serious crisis of bad investment. That’s why even Randians like Alan Greenspan have called for some sort of temporary nationalization. Or “the Swedish Solution.”
What surprises me is that, to my humble ears out here in Portland, OR, it sounded like some American version of the Swedish Solution had already attained Conventional Wisdom status months ago. That is, it seemed like the kind of plan Obama and Washington Consensus types would cobble together and move forward with. Yet last February Geithner announced a variation of the Paulson plan that, in effect, sucks money out of the Federal Treasury we should be using for, I dunno, a National Health Care Plan, and leaves the American people holding giant bags of guano. Geithner was sketchy about the details then and the leaked plan is less than fully fleshed out, yet it already appears — at least to economics brains better informed than my own — that he has created a Rube Goldberg elaboration of the original Paulson plan.
Krugman and other liberals have been wringing their hands that last week’s populist outrage over AIG bonuses would begin to undo the popular support Obama needs to carry forward his (supposedly) progressive agenda. E.J. Dionne puts the problem in ideological terms:
The Obama administration is courting danger if it does not offer a clear moral and philosophical analysis of what went wrong in the economy — and an understandable case for what it’s doing to fix things.
The worst outcome for Obama would be for the public to see his bank rescue efforts as a colossally inefficient waste of money and an attempt to rescue the financiers from their own foolishness and greed. This would tag the president with the least popular aspects of both liberalism and conservatism. There would be nothing pragmatic about that.
Em-phass-is mine. Actually, I think the worst outcome would be for the public to be right — yet still be completely powerless to do something about it. You know who would be really happy, though? Rush Limbaugh.