We have written an expositional article describing how we got into the current financial mess and what to do about it. Here is the beginning and end of the article:

Everyone knows that the United States faces a serious financial crisis and that the Administration is asking for an astoundingly large sum of money to fix the problem. Fewer may know what economists think about the crisis. Most academic economists - the economists who do not work for companies likely to benefit from the bailout, nor for the President - are opposed to this plan. This large group of experts has wide ranging political opinions, and includes democrats, republicans, and most likely some libertarians. So: why is there a crisis, what is this plan, and why are a large number of academic economists opposed to it?

...

The bottom line, in the immediate future, is this. The Federal Reserve Bank and its sister agencies such as the Federal Deposit Insurance Corporation (FDIC) already have strong tools against a cascading failure of the banking system. They has been using those tools, including advancing credit to banks through the discount window, insuring deposits, and selectively allowing institutions to fail. We have seen isolated bank failures. There will be more in the future. We have not seen good banks fail, nor have we seen cascading failures. We have been given no reason to think anything of the sort is imminent. It is sad to say that despite this the U.S. Government is in a state of panic. Supposedly knowledgeable government officials talk as if ATMs might stop working and firms will not be able to meet their payrolls. This is utter nonsense. To debunk the obvious: Washington Mutual failed Thursday night. Washington Mutual ATM cards continue to function as usual. Individual and corporate bank accounts are federally insured up to $100,000 per bank. The normal process of bank closure does not prevent bank customers from accessing their funds. As to payroll: We do not doubt that some firms of various sizes are going to fail to meet payroll and go bankrupt in the next weeks. It is likely that a few of them would have been able to survive if credit was more widely available at the moment. But most firms do not meet payroll by short-term borrowing. The fact that banks are reluctant to lend to each other does not have much impact on their ability to make short term loans to customers. And so on.

No objective reading of data we have access to indicates anything near as bad as the claims that are being made. It may be that eventually more intervention than the Federal Reserve and Treasury can do without Congressional action will be needed. However, this is not a natural calamity or a war where there will be large and irreparable harm if we do not act immediately. There is adequate time for the public, the Congress, the Treasury and Federal Reserve to think through the alternatives carefully, to monitor the situation with equal care, and if necessary intervene in markets in a way that makes sense.

Public officials, especially the Chairman of the Federal Reserve Board have an obligation to explain these facts and reassure people that they are not in danger of a catastrophic collapse. It is rather unfortunate, then, the opposite seems to be occurring. For example, on September 24 Ben Bernanke declared in front of Congress:

All told, real gross domestic product is likely to expand at a pace appreciably below its potential rate in the second half of this year and then to gradually pick up as financial markets return to more-normal functioning and the housing contraction runs its course. Given the extraordinary circumstances, greater-than-normal uncertainty surrounds any forecast of the pace of activity. In particular, the intensification of financial stress in recent weeks, which will make lenders still more cautious about extending credit to households and business, could prove a significant further drag on growth. The downside risks to the outlook thus remain a significant concern. ...

Over time, a number of factors should promote the return of our economy to higher levels of employment and sustainable growth with price stability, including the stimulus being provided by monetary policy, lower oil and commodity prices, increasing stability in the mortgage and housing markets, and the natural recuperative powers of our economy. However, stabilization of our financial system is an essential precondition for economic recovery. I urge the Congress to act quickly to address the grave threats to financial stability that we currently face. For its part, the Federal Open Market Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability.

Roughly speaking he said "things are not too bad, but gradually getting worse, and you better act quickly to give us $700 billion to fix it." The conclusion does not seem to follow. It is not surprising that people imagine that there is far more catastrophic information that he is not telling us. If the Federal Reserve Bank and Treasury in fact have information that things are worse than Bernanke reported they should tell us what it is. Otherwise they should stand up and make it clear that doomsday is not around the corner.

David and Michele,

All I can say is (and apologies the those born sometime after me) right on! As far as I can tell, once the Fed/Treasury can stabilize the commercial paper market, then we have time to get through the election and leave this to the next President to solve, for better or worse (and better, I hope). And, anyone who thinks that giving the Wall Street Decision Makers a free ride on this is the right answer, then I've got a country in the Middle East (not far from Kuwait and Iran) that I'm willing to sell you.

Steve

I read the article. Very good. As a Brazilian and living next to Argentina, I would only apoint that, despite these data of Argentina GDP (what is the source of them?), their standard of live suffered a real fall. Actualy, about 50% of people entered under poverty line (altough not so much if we measure their GDP in ppp). Anyway, I think that if you guys wuant good image of what happend there you should look the percentual variation in real GDP these years, measuring in Pesos Argentinos. I dont' have all the facts here, but I remember of real GDP falling about 11% from 2001 to 2002.

As far as I know they experienced some deflation, what could explain (some part, at least) the difference between the data (variation in GDP PPP and in real GDP in pesos). Yet, I think these data are somewhat weird.

So, I would just look to these numbers. The rest is just perfect.

Regards, Manoel

I would scarcely hold up Argentina as a good policy example to follow. They did a number of stupid things during the crisis - including destroying the savings a large part of the middle class. Unemployment was high, there were street protests, crime went up. They were also in a much tougher position than the U.S. is now, with an unsustainable fiscal policy and debt they could not repay. It was thought that if they defaulted, credit markets would freeze, and they did. It was also widely thought that this would result in a dramatic fall in output - exactly what seems to be concerning policy makers in the U.S. now. To the surprise of many of us that did not happen: there were some important bankruptcies, but by and large businesses were able to go on operating under much more difficult circumstances than anyone envisions for the U.S.

The PPP adjusted data we used is from here. There are definitely some very strange things in PPP adjusted data. Here from the same source is the constant US $2000 data

2005 8,094.17

2004 7,486.246

2003 6,932.447

2002 6,430.982

2001 7,288.479

2000 7,702.893

1999 7,847.368

1998 8,212.903

which as you say shows about a 12% drop from 2001 to 2002. By way of contrast, the during the Great Depression in the U.S. GDP declined by about 30% and remained low for almost a decade. In Argentina the recession only lasted about two years following the default. The default was at then end of December 2001, the bank account freeze at the beginning of the month. Notice that per capital GDP also fell nearly 6% the previous year which can't be attributed to the default. There were many problems during the period - I forget how many Presidents they went through in how many days, but it was quite a few.

In fact, I agree with you that Argentina isn't a good example of policy to follow. After all, they suffered a lot, besides the political problems you cited.

And just to agree in one more thing, the very same people who now predict a catastrophe in US if the bailout is postponed just a few days to discuss it a little more are the people who predicted Argentina would be in a bad situation for several years after 2001.

Manoel

A good criticism of the bailout. The part about overcoming the lemon problem is especially good. Why not shrink the article and send it to the op-ed page of the WSJ?

BB&T CEO John A. Allison wrote a letter against the bailout, unlike Bank of America CEO Kenneth Lewis, who defended it as allegedly good for Main Street in the WSJ.

Here is John Allison's letter:

bailout_critique

Get it proofread before submitting elsewhere or it will sound like "I can has cheezburger", i.e.

"They has been using those tools"