Greg Mankiw has posted a careful email from Rob Shimer explaining why the bailout plan (whether 700 or 350 billion) is a bad idea. Note that Rob does not argue against any government action. Nor would I. He echoes the thoughtful idea that beyond the obvious moves that the Fed and other agencies have been making to prevent bank runs, banks should be forced to recapitalize (they could also be forced to stop paying dividends, although he does not mention this). By making them all do this, this solves the lemons problem that is freezing financial markets, and may also force the truly insolvent banks out into the open.

In a nutshell the problem is that the decline in assets (mortgages) that banks hold means that they are now undercapitalized. The banks willing to offer the best deal to investors to raise more capital are those in the greatest trouble. This means that any attempt by any bank, no matter how solvent, to raise capital serves as a red flag to the market. If all banks are required by the government to raise more capital, then it is no longer the case that raising capital means a bad balance sheet, so it becomes possible for good banks to raise capital.

I want to add on other thing to the "Ben had more information than anybody who signed the anti-bailout letter." Ben is certainly a smart guy. And he certainly has more information than we do. But: if he has information that the situation is catastrophic then now is the time to tell us what it is. There was another letter writer on Greg's blog who seemed to argue that without a bailout firms weren't going to be able to meet their payroll come Tuesday. That shows such an abysmal level of ignorance that I can't fathom why Greg published it. Of course everyone who signed the anti-bailout letter wants firms to meet their payroll on Tuesday or any other day. And every single one of us knows that whether or not that happens has nothing to do with whether or not the bailout plan is approved. The only smart thing about that letter write is that he chose to remain anonymous.

David, "Note that Rob does not argue against any government action. Nor would I."

Why not? The state is inherently criminal and corrupt, not to mention inept. It was government action that caused this problem. Why would anyone trust any governmental action ever, especially one pretending to rescue us from the very problem caused by the state, all the while blaming it on the free market.

"He echoes the thoughtful idea that beyond the obvious moves that the Fed and other agencies have been making to prevent bank runs, banks should be forced to recapitalize (they could also be forced to stop paying dividends, although he does not mention this). By making them all do this, this solves the lemons problem that is freezing financial markets, and may also force the truly insolvent banks out into the open."

Why should a bank be forced by the state to recapitalize? If it needs to do it, let it do it on its own. The only beneficial thing the state can do is to abolish the fed, define the dollar in terms of gold, and allow gold to rise as real money.

I am in favor of the government intervening in asset markets at the current time. It's not that I think an unregulated system would do worse than the current system, although I'm not an anarchist in the sense that I do not think the federal reserve system is the work of the devil. Moreover, I don't think the gold standard is a good idea, rather that it is a proven bad idea. But there are competitive systems of providing fiat money through private banking. There is a sensible debate about these systems and the gold standard, and about whether asset markets should be regulated, insured and so forth by the government. At the moment it doesn't matter. Asset markets are regulated, and whatever I might think about that regulation, the solution to any problem that occurs is not to immediately relax or limit regulation. I don't support allowing the banking system to collapse in hopes that it might be replaced by an unregulated system. To deregulate it immediately would create a catastrophe, the most likely outcome of which would be that it would be replaced by a more regulated and worse system than the current one.

(I should point out that while I'm in favor of eliminating patents, I'm not in favor of immediately abolishing them...any change of that magnitude needs to be phased in carefully and gradually. Existing ways of doing business are carefully adapted to existing institutions, and brutal abrupt change makes it difficult to adjust to the new rules with predictably disastrous consequences. This not only make everyone worse off in the short run, but also convinces people that the change was a bad idea.)

I see the issue as one of what needs to be done now to prevent a collapse, with the broader issue of what to do next taking place over a much longer time frame. One crucial thing is the need to consider the long term consequences of current action. Simply bailing people out predictably leads to future institutions and behavior that will be even worse than what we have now.

If the government is going to insure individual accounts it must oversee bank portfolios. A half-system in which they insure accounts but do not oversee bank portfolios is a lot worse than a system in which they either do neither or both. Similarly, given the system as it exists right now for the Federal reserve bank not to intervene to provide loans would be a disaster. I'm against bailing out the people that foolishly lost money, although in the scheme of things I'm more opposed to bailing out rich people than poor people. But since the government in the current system has the responsibility for overseeing bank portfolios, yes, it should use the responsibility correctly. It shouldn't, for example, refuse to require banks to acquire more capital on the grounds that a system with no government regulation would be preferable to the current system.

"The state is inherently criminal and corrupt, not to mention inept. It was government action that caused this problem." I will agree, to the extent, that the Republican's are bringing Orwell's "1984" into reality. In fact, one of my pet sayings is a Government of, by, and for the corporations. However, I would like to believe that the State is not inherently criminal and corrupt. Obviously, I might be somewhat schizophrenic.

What I see as the operative dynamic is that the Government has been corrupted by lobbyists to create favorable legislation for the corporations. Fast money reported that five financial firms asked the SEC to reduce certain regulations. As a consequence: "In 2004 the SEC failed to properly regulate Credit Default Swaps or insurance policies on mortgages. Financial institutions were allowed to hold only 3 cents for every dollar of risk.". The Government may have facilitated the our emerging financial collapse, but it was the willful self-interest planning and self-interest actions of corporate executive that created this problem.

On the gold standard. I have never been a fan of the gold standard. However, we have debased our currency as can be seen in the rise of commodity prices and the Euro. So I will have to acknowledge that we need to restore the value of the dollar.

Yes...we seem to be in danger of moving from capitalism to corporate capitalism ("what is good for General Motors is good for the country"). Not only does bailing people out now lead to bad incentive down the road, it will be a lot harder to say no next time some sector wants a bailout. A $25 billion bailout of the automobile industry passed the other day, obscured by the controversy over the much larger proposed bailout of the financial industry.

Hi, I admire a lot your work in this blog, although I do not share your liberal vision about government, free market (in general) and so on. Anyway, I am completly an outsider (an economist of Brazil, actually now a political scientist) but can't imagine if it is the politics of academic profession that avoid some of you of asking: Why is Mankew talking like this? Is because he was a former economist working with this government? Is he saying you guys in US shoudn't express your opinions because you don't know what Bernake knows? Do you guys realize how this is so against democracy?

By the way, here in Brazil we had a lot of crisis some time ago and IMF and others have always advised us to cut employment, let our firms go down and cut Government budget. We experienced bad education, problems with health care, problems with criminals because of this and now, what was that? Where is moral Hazard you guys talked so much? Just vanished in one single day?

Regards,

Manoel

Hi, I admire a lot your work in this blog, although I do not share your liberal vision about government, free market (in general) and so on. Anyway, I am completly an outsider (an economist of Brazil, actually now a political scientist) but can't imagine if it is the politics of academic profession that avoid some of you of asking: Why is Mankew talking like this? Is because he was a former economist working with this government? Is he saying you guys in US shoudn't express your opinions because you don't know what Bernake knows? Do you guys realize how this is so against democracy?

By the way, here in Brazil we had a lot of crisis some time ago and IMF and others have always advised us to cut employment, let our firms go down and cut Government budget. We experienced bad education, problems with health care, problems with criminals because of this and now, what was that? Where is moral Hazard you guys talked so much? Just vanished in one single day?

Regards,

Manoel

Mankiw is certainly being coy, publishing letters from both sides and not taking a stand. Perhaps he hopes to get a government position in the future and thinks if he takes sides he would hurt his chances? Or perhaps he genuinely doesn't know if it is a good idea or not.

I wish the moral hazard had vanished in just one day, or even a week. Unfortunately the bailout is going to create ridiculous amounts of moral hazard without doing that much to solve the banking problems.

Hi, I admire a lot your work in this blog, although I do not share your liberal vision about government, free market (in general) and so on. Anyway, I am completly an outsider (an economist of Brazil, actually now a political scientist) but can't imagine if it is the politics of academic profession that avoid some of you of asking: Why is Mankew talking like this? Is because he was a former economist working with this government? Is he saying you guys in US shoudn't express your opinions because you don't know what Bernake knows? Do you guys realize how this is so against democracy?

By the way, here in Brazil we had a lot of crisis some time ago and IMF and others have always advised us to cut employment, let our firms go down and cut Government budget. We experienced bad education, problems with health care, problems with criminals because of this and now, what was that? Where is moral Hazard you guys talked so much? Just vanished in one single day?

Regards,

Manoel

Hi, I admire a lot your work in this blog, although I do not share your liberal vision about government, free market (in general) and so on. Anyway, I am completly an outsider (an economist of Brazil, actually now a political scientist) but can't imagine if it is the politics of academic profession that avoid some of you of asking: Why is Mankew talking like this? Is because he was a former economist working with this government? Is he saying you guys in US shoudn't express your opinions because you don't know what Bernake knows? Do you guys realize how this is so against democracy?

By the way, here in Brazil we had a lot of crisis some time ago and IMF and others have always advised us to cut employment, let our firms go down and cut Government budget. We experienced bad education, problems with health care, problems with criminals because of this and now, what was that? Where is moral Hazard you guys talked so much? Just vanished in one single day?

Regards,

Manoel

Sorry for the repeated messages. I don't Know what happend... Sorry again, guys.