Home buyer tax credit = more global warming

According to Harvard economist Edward Glaeser, Congress and the White House are intent on harming the planet:

ENVIRONMENTALISTS who are worried about global warming should pay attention to the congressional debate about extending the home buyers tax credit. Federal tax policies toward housing have long encouraged Americans to emit more carbon. President Obama could do the country, and the planet, a service by either refusing to sign the extension of the $8,000 credit or by insisting that it be accompanied by offsetting reductions in the home mortgage interest deduction.

According to the Residential Energy Consumption Survey, per person energy use in owner-occupied housing is 39 percent higher than in rental units. Energy use, per household member, is 49 percent higher in single-family detached houses than in apartments in buildings with more than five units. These differences reflect the strong connection between home size and energy use. The average four-bedroom house consumes 72 percent more electricity than the average two-bedroom house.

Yet the tax code encourages Americans to live in big, energy-guzzling homes, instead of thrifty apartments, and Congress seems intent on further unbalancing the federal budget to egg on home buyers.

Cash for Clunkers cost $24,000 per car

Edmunds.com has analyzed the car sales numbers during the Cash for Clunkers program and estimated that the marginal cost was $24,000 of our tax dollars for each new car sold:

A total of 690,000 new vehicles were sold under the Cash for Clunkers program last summer, but only 125,000 of those were vehicles that would not have been sold anyway, according to an analysis released Wednesday by the automotive Web site Edmunds.com. ...

The Cash for Clunkers program gave car buyers rebates of up to $4,500 if they traded in less fuel-efficient vehicles for new vehicles that met certain fuel economy requirements. A total of $3 billion was allotted for those rebates.

The average rebate was $4,000. But the overwhelming majority of sales would have taken place anyway at some time in the last half of 2009, according to Edmunds.com. That means the government ended up spending about $24,000 each for those 125,000 additional vehicle sales.

The average rebate value mentioned above seems like bad rounding. It appears the average rebate was closer to $4,348. Here's the math:

$3 billion overall cost ÷ 690,000 cars sold = $4,348 per car total cost

(690,000 / 125,000) × $4,348 = $24,000 per car marginal cost

In an example of regulatory capture (government regulators protecting the industry they are supposed to regulate), the Department of Transportation is defending Cash for Clunkers (i.e. "Car Allowance Rebate System") by saying that it was good for the auto industry:

"It is unfortunate that Edmunds.com has had nothing but negative things to say about a wildly successful program that sold nearly 250,000 cars in its first four days alone," said Bill Adams, spokesman for the Department of Transportation. "There can be no doubt that CARS drummed up more business for car dealers at a time when they needed help the most."

Note that what's good for car dealers is not necessarily what's good for the overall economy, just as what's good for Realtors is not necessarily what's good for the overall economy. Like the first-time home buyer tax credit, Cash for Clunkers is nothing more than wasteful corporate welfare.

The White House has come out with a weak, short-term-oriented defense of the program. Notice, however, that for the most part the left-wing economics bloggers who are usually quick to defend the White House against faulty economic reasoning (e.g. Paul Krugman, Mark Thoma, Calculated Risk) are remaining silent on this one. In fact, left-leaning economist Jeffrey Sachs is out with his own criticism of Cash for Clunkers' supposed climate benefits. Sachs actually makes the mistake of measuring total cost, rather than marginal cost, so the program is actually 5.5 times more wasteful than the numbers he complains about.

Just like the first-time home buyer tax credit, Cash for Clunkers is a handout of our tax money to the special interests who lobby Congress.

Paulson says more capital injections needed

Treasury Secretary Hank Paulson says more bank capital injections are needed:

The second half of the financial industry bailout fund should be used mostly for direct capital injections into troubled banks and financial firms, Treasury Secretary Henry Paulson said Friday.

"At least in my judgment, a good portion of the TARP resources has to be used for capital programs," Paulson told reporters in his final press conference as Treasury Secretary.

Congress is working quickly on releasing the second half of the $700 billion war chest. The Senate voted on Thursday to release the funds.

Paulson said he understood the public's impatience that the massive spending has not solved the financial crisis.

But he said the plan has been essential for financial market stability.

Paulson defended his record in combating the financial market failure and resulting credit crunch.

"I think history will look and say that maybe around the edges we might have done things differently, but the big decisions we've made have been the right ones and I think will stand the test of time," he said.

Although he was as frustrated as anyone that banks are not lending more, lending is naturally lower in a recession, he said. The key is that lending is higher than it would be without the Bush administration's efforts, he said.

President-elect Obama will face the same frustration with his economic stimulus plan, Paulson said.

I agree with Hank Paulson. I originally opposed bank bailouts, but Milton Friedman changed my mind.

Keep in mind that capital injections are not a handout to the financial industry. The banks do have to pay the government (i.e. the taxpayer) dividends in exchange for the capital. The banks need to continue paying dividends to the government taxpayer until the banks repay the principal. If the government borrows at a rate of 3% and the banks pay a dividend to the government of 5-8%, then the government taxpayer is netting 2-5% on the capital injections.

Bernanke says banks need more money

From MarketWatch:

There will be no "lasting" recovery without more government action and additional money to strengthen the financial system, Federal Reserve Chairman Ben Bernanke said Tuesday.

The timing and strength of economic recovery "are highly uncertain," Bernanke told an audience in London.

In what's likely to be a sobering message to Congress, Bernanke did not say the end was near. He said that the stimulus package championed by President-elect Barack Obama would likely help the economy but wouldn't be enough on its own.

"In my view ... fiscal actions are unlikely to promote a lasting recovery unless they are accompanied by strong measures to further stabilize and strengthen the financial system," Bernanke said.

The next step is to get toxic assets off bank balance sheets, he said. He outlined several ways to do this, including setting up "bad banks" to hold the troubled assets, mostly mortgage debt.

As yet, the financial crisis has no end in sight, given the weak economy, Bernanke said.

Martin Feldstein opposes the automaker bailout

Video: Harvard economist Martin Feldstein says a managed bankruptcy is preferable to the current bailout proposal.

Krugman: Detroit auto industry will likely disappear

Nobel Prize–winning economist Paul Krugman says the U.S. Detroit auto industry will likely disappear:

Nobel economics prize winner Paul Krugman said Sunday that the beleaguered U.S. auto industry will likely disappear.

"It will do so because of the geographical forces that me and my colleagues have discussed," the Princeton University professor and New York Times columnist told reporters in Stockholm. "It is no longer sustained by the current economy."

Krugman won the 10 million kronor (US$1.4 million) Nobel Memorial Prize in economics for his work on international trade patterns. Some of his research on economic geography seeks to explain why production resources are concentrated in certain locations.

Speaking to reporters three days ahead of the Nobel Prize ceremony, Krugman said plans by U.S. lawmakers to bail out the Big Three automakers were a short-term solution, resulting from a "lack of willingness to accept the failure of a large industry in the midst of an economic crisis."

I'd say that's only true if you don't count the foreign-owned auto manufacturing plants in the southern U.S. to be part of the U.S. auto industry. This raises the question: If they employ 113,000 workers, does it really matter if the auto plants are foreign owned?

Krugman's comments also raise another question: If the big three automakers are going to go away anyhow, should politicians really be handing them tens of billions of your tax dollars?

Hat tip: Greg Mankiw.

Update: Paul Krugman says his words were misreported. It's the Detroit auto industry that will disappear, not the U.S. auto industry. This makes much more sense.

Americans oppose automaker bailout

Hopefully the politicians will listen to the people:

A national poll suggests that six in 10 Americans oppose using taxpayer money to help the ailing major U.S. auto companies.

Sixty-one percent of those questioned in a CNN/Opinion Research Corp. survey out Wednesday are dead set against the federal government providing billions of dollars in assistance the the auto makers, with 36 percent favoring such a bailout.

The poll, conducted Monday and Tuesday, also indicates that a majority of Americans, 53 percent, don't think government assistance for the auto makers will help the U.S. economy. ...

Opposition to the bailout of the auto industry is widespread across the country, even the Midwest, where the domestic auto makers have their headquarters and many of their assembly plants.

The poll indicates that most opposition to the bailout comes from the West, where opposition reaches 67 percent. Sixty-one percent of those polled in the Northeast, 64 percent in the South and 53 percent in the Midwest oppose using federal dollars to help the auto makers.

The poll also suggests that a vast majority of Republicans, 70 percent, oppose the bailout, with 62 percent of independents and 55 percent of Democrats also opposed.

Again, Nobel Prize–winning economist Gary Becker says bankruptcy, not a bailout, is best for the American automakers in the long run.

The case for an automaker bailout

Video: While I oppose an automaker bailout, here Morningstar analysts make the case in favor of an automaker bailout.



Nobel Laureate Paul Krugman makes his case:



The case against a bailout is here.

Buffett says Detroit automakers must change

Warren Buffett gave his thoughts on the automakers in a recent interview:

Billionaire investor Warren Buffett said U.S. automakers need a new business model to better compete, whether it takes bankruptcy or a government bailout to achieve.

Buffett said any automaker bailout package should include a business solution and be negotiated by the president, not Congress.

The government should insist top executives at Ford Motor Co., General Motors Corp. and Chrysler LLC invest a significant percentage of their own net worth in the Detroit-based companies, Buffett said, ensuring both executives and taxpayers would share in any profits or losses.

Buffett said the government should be able to drive a deal like one of the ones he makes when Berkshire buys businesses, because automakers appear on the brink of bankruptcy.

Buffett said he'd tell the auto executives, "'We'll give you more upside [than bankruptcy], but you're going to lose if we lose."'

Bankruptcy would be a poor solution for the auto industry, Buffett said, so he hopes a better way can be found to work out the union contracts and other issues the companies face.

Automaker bankruptcy will lead to streamlined operations

Nobel Laureate Gary Becker opposes an automaker bailout:

The big three American auto producers General Motors, Ford, and Chrysler, are in terrible financial shape. They have asked the government for a bailout, and the Democratic leadership in Congress is eager to give them one. The United Auto Workers union was a strong supporter of President-elect Obama and of Democratic candidates.

These companies have lost tens of billions of dollars during the past few years, and they will shortly run out of cash. ... All three companies were heavily into producing trucks and SUV's when the sharp run up in gas prices induced consumers to shift away from these gas-guzzlers and toward smaller and more fuel-efficient cars. ...

If GM is not bailed out, the company claims it will be forced into bankruptcy within a few months, and Ford's situation is only slightly better. ...

Nevertheless, I believe bankruptcy is better than a bailout for American consumers and taxpayers. The main problem with American auto companies is that during the good times of the 1970s, 1980s and 1990s, they made overly generous settlements with the United Auto workers (UAW) on wages, pensions, and health benefits. ...

It is not that cars cannot be produced profitably with American workers: the American plants of Toyota and other Japanese companies, and of German auto manufacturers, have been profitable for many years. The foreign companies have achieved this mainly by setting up their factories in Southern and border states where they could avoid the UAW, and thereby introduce efficient methods of production. Their workers have been paid well but not excessively...while still maintaining good morale among their employees. ... As a result of lower costs, better management, and less hindrance from work rules imposed by the UAW, about 1/3 of all cars produced in the US now come from foreign owned plants.

Bankruptcy would help GM and Ford become more competitive by abrogating significant parts of their labor contracts with the UAW. ... Bankruptcy should also help bring the wage rates of GM and Ford in line with those of foreign producers in the US. ...

Bankruptcy may also force out the current management of GM and Ford. ... When a company consistently does badly while some of its competitors (like Toyota) are doing well, its time to fire the management team, and see if another team can do better.

Much of why the Big Three can't compete, summed up in a single graph courtesy of Mark J. Perry:


Update: Felix Salmon is critical of Mark Perry's graph.

Update #2: Megan McArdle criticizes Felix Salmon's reasoning.

General Wesley Clark's bailout argument is fallacious

General Wesley Clark makes a sweet-sounding, but fallacious, argument in favor of bailing out Detroit automakers:

AMERICA’S automobile industry is in desperate trouble. Financial instability, the credit squeeze and closed capital markets are hurting domestic automakers, while decades of competition from foreign producers have eroded market share and consumer loyalty. Some economists question the wisdom of Washington’s intervening to help the Big Three, arguing that the automakers should pay the price for their own mistakes or that the market will correct itself. But we must act: aiding the American automobile industry is not only an economic imperative, but also a national security imperative.

When President Dwight Eisenhower observed that America’s greatest strength wasn’t its military, but its economy, he must have had companies like General Motors and Ford in mind. Sitting atop a vast pyramid of tool makers, steel producers, fabricators and component manufacturers, these companies not only produced the tanks and trucks that helped win World War II, but also lent their technology to aircraft and ship manufacturing. The United States truly became the arsenal of democracy.

During the 1950s, advances in aviation, missiles, satellites and electronics made Detroit seem a little old-fashioned in dealing with the threat of the Soviet Union. The Army’s requests for new trucks and other basic transportation usually came out a loser in budget battles against missile technology and new modifications for the latest supersonic jet fighter. Not only were airplanes far sexier but they also counted as part of our military “tooth,” while much of the land forces’ needs were “tail.” And in those days, “more teeth, less tail” had become a key concept in military spending.

But in 1991, the Persian Gulf war demonstrated the awesome utility of American land power, and the Humvee (and its civilian version, the Hummer) became a star. Likewise, the ubiquitous homemade bombs of the current Iraq insurgency have led to the development of innovative armor-protected wheeled vehicles for American forces, as well as improvements in our fleets of Humvees, tanks, armored fighting vehicles, trucks and cargo carriers.

In a little more than a year, the Army has procured and fielded in Iraq more than a thousand so-called mine-resistant ambush-protected vehicles. The lives of hundreds of soldiers and marines have been saved, and their tasks made more achievable, by the efforts of the American automotive industry. And unlike in World War II, America didn’t have to divert much civilian capacity to meet these military needs. Without a vigorous automotive sector, those needs could not have been quickly met.

More challenges lie ahead for our military, and to meet them we need a strong industrial base.

Bankruptcy does not mean ceasing operations. Chapter 11 bankruptcy is designed to help companies streamline operations and become profitable again. GM, Ford, and Chrysler want bailout money so they can avoid bankruptcy.

If any one of the Big Three did cease operations it would reduce competition, thus increasing revenues for the remaining two.

Furthermore, General Wesley Clark doesn't seem to realize that there are plenty of automobile manufacturing plants in the United States owned by companies like Toyota, Nissan, Kia, Volkswagen, BMW, etc. If all of the Big Three go under, foreign automakers will gain larger market share and that will require them to build more automobile plants in the Mississippi River Valley.

Finally, Japan buys their air force tanker aircraft from the United States (Boeing). Why can't we buy military automobiles from Japan and our NATO allies?

An automaker bailout is harmful in the long run

Daniel J. Mitchell asks us to say "no" to an automaker bailout:

General Motors, Ford, Chrysler and the United Auto Workers union are pouring millions of dollars into a lobbying campaign for a taxpayer bailout. ...

A taxpayer bailout would be a terrible mistake. It would subsidize the shoddy management practices of the corporate bureaucrats at General Motors, Ford and Chrysler, and it would reward the intransigent union bosses who have made [them] synonymous with inflexible and anti-competitive work rules.

Perhaps most important, though, is that a bailout would be bad for the long-term health of the American auto industry. It would discriminate against the 113,000 Americans who have highly-coveted jobs building cars for Nissan, BMW and other auto companies that happen to be headquartered in other nations.

These companies demonstrate that it is possible to build cars in America and make money. Putting them at a competitive disadvantage with handouts for the U.S.-headquartered companies would be highly unjust.

A bailout also would be bad for General Motors, Ford and Chrysler. The so-called Big Three desperately need to fundamentally restructure their practices. More specifically, the car companies need to endure some short-term pain in order to restore long-term viability. But that won't happen if politicians raid the treasury. ...

• A bailout will hurt the overall economy by misallocating resources. ...
  
• A bailout will encourage other industries to seek taxpayer handouts. ...
  
• A bailout is a perverse transfer from poor taxpayers to rich taxpayers. ...
  

Chapter 11 protection may be precisely what is needed to put American auto companies back on the path to profitability. Bankruptcy laws specifically are designed to give companies an opportunity — under court supervision — to reduce costs and streamline operations.

Bankruptcy would not be popular in some quarters, to be sure. The bloated management structure would be streamlined and many overpaid executives would be unhappy about having to find new jobs.

The UAW would be equally upset, particularly since bankruptcy might force an end to extravagant pension benefits and inefficient workplace practices. But bankruptcy is akin to getting an alcoholic to put down the bottle. There clearly will be short-term discomfort, but compassionate people recognize that this is the best approach.

Treasury's proposed bailout of credit cards is not helpful

James Surowiecki criticizes the now proposed Treasury bailout of consumer debt:

There is no way that having the U.S. government subsidize credit-card lending makes sense. But yesterday Henry Paulson seemed to suggest that that’s what TARP funds would, among other things, now be used for. ...

What, exactly, is the harm that we’re trying to remedy by making it easier for people to use credit cards? That people aren’t shelling out enough of their money to cover exorbitant interest payments? Are we really saying that the wellbeing of the U.S. economy depends so much on people borrowing money at fifteen to nineteen per cent that we’re willing to spend taxpayer money subsidizing that market? I’m sorry, but there’s no way that’s true. ...

There are lots of things the government can and should be spending its money on to get the economy moving again. But on any list of those things, subsidizing credit-card issuance has to be right near the bottom.

Details on the banking equity injection

Bloomberg provides details on the Treasury's investment in U.S. banks:

The Bush administration will invest about $125 billion in nine of the biggest U.S. banks...

The proposed cash injections in exchange for preferred shares are part of a $700 billion rescue approved by Congress and follow similar moves by European leaders to unfreeze credit markets by helping beleaguered banks. ...

The purchases represent a new approach for Treasury Secretary Henry Paulson, who first promoted a bailout targeted at illiquid mortgage-related assets. The urgency for a more immediate infusion has grown as banks struggle to regain the confidence of investors, counterparties and clients after bad loans caused more than $635 billion of writedowns across the industry. Paulson will discuss his plan at a press conference at 8:30 a.m. today in Washington. ...

The Treasury plans to spend $25 billion each for stakes in Citigroup and JPMorgan, people said. Another $25 billion will be divided between Bank of America and Merrill, which agreed last month to be acquired by Bank of America. Wells Fargo is to get at least $20 billion, Goldman and Morgan Stanley will each get $10 billion, and State Street and Bank of New York will get about $3 billion each, people said.

The government will obtain its stakes with a type of security designed not to dilute the value of common shares.

None of the nine banks getting government money was given a choice about it, said people familiar with the plans. All of the banks involved will have to submit to compensation restrictions as mandated by Congress, people said.

I find the second to last sentence disturbing. Is America still a free country? Government has made a big grab for power under President Bush, starting with the Patriot Act. Now the government is forcing banks to sell parts of themselves. I wouldn't be as bothered if banks were voluntarily letting the government invest. But force? Does JPMorgan even need the money?

More details from The New York Times:

The preferred stock that each bank will have to issue will pay special dividends, at a 5 percent interest rate that will be increased to 9 percent after five years. The government will also receive warrants worth 15 percent of the face value of the preferred stock. For instance, if the government makes a $10 billion investment, then the government will receive $1.5 billion in warrants. If the stock goes up, taxpayers will share the benefits. If the stock goes down, the warrants will be worthless.

By comparison, the U.S. inflation rate over the past year has been 5.4%.

Nobel laureate Gary Becker gives his thoughts on the financial crisis

Nobel Prize–winning economist Gary Becker says the current financial crisis is minor compared to the Great Depression:

The magnitude of this financial disturbance should be placed in perspective. Although it is the most severe financial crisis since the Great Depression of the 1930s, it is a far smaller crisis, especially in terms of the effects on output and employment. The United States had about 25% unemployment during most of the decade from 1931 until 1941, and sharp falls in GDP. Other countries experienced economic difficulties of a similar magnitude. So far, American GDP has not yet fallen, and unemployment has reached only a little over 6%. Both figures are likely to get quite a bit worse, but they will nowhere approach those of the 1930s.

He is not fond of government bailouts, but he has this to say about TARP:

Taxpayers may be stuck with hundreds of billions of dollars of losses from the various government insurance provisions and government purchases of assets. Although the media has made much of this possibility through headlines like "$700 Billion Bailout," such large losses are highly unlikely except in the low probability event that the economy falls into a sustained major depression. Indeed, with efficient auctions, the government may well make money on its actions, just as the Resolution Trust Corporation that took over many savings-and-loan banks during the 1980s crisis did not lose much, if any, money. By buying assets when they are depressed and waiting out the crisis, the government may have a profit on these assets when they are finally sold back to the private sector. Making money does not mean the government involvement is wise, but the likely losses to taxpayers are being greatly exaggerated.

Jeremy Siegel's take on the bailout

Wharton Business School finance professor Jeremy Siegel gives his thoughts on TARP:

It is possible that the plan can be a "win" for both taxpayers and banks. One of the central tenets of economics is that a trade often involves gains to both parties and this is no exception.

The collapse of the housing market has sharply lowered the price of real estate, so many of the mortgages and securities issued against homes are now "under water," or worth less than the value of the house. If a lender wrote a $300,000 mortgage on a house that is now worth only $150,000, the "intrinsic" or underlying value of the loan is now 50 cents on the dollar. ...

But in these stressed times, the lot for mortgage lenders is even worse. Because of the current illiquidity of the mortgage-backed security markets and the confusion of ownership rights of some of these complex securities, investors are willing to pay only 30 cents on the dollar or less for an asset with a 50 cent intrinsic value. It is in this situation where the government has an opportunity to improve the lot of the buyer and seller. The Treasury has the ability to hold these assets until the mortgage is restructured in order to realize the intrinsic value of the loan.

This does not mean a recovery of 100 cents on the dollar, but, if the government can buy the loan for 40 cents, it can still receive a good return on the investment if prices eventually rise to only 50 cents. In the meantime, the financial institution has swapped a distressed asset for a highly liquid security.

Buffett suggests improvement to TARP

From Fortune Magazine:

Warren Buffett suggested Thursday that the U.S. Treasury team with private investors to buy the distressed mortgage assets at the center of the controversial $700 billion Wall Street bailout, and said the price tag of the rescue plan may have to rise.

Buffett, the chairman and CEO of Berkshire Hathaway, called the problems facing world markets "unprecedented" and warned of a "disaster" if Congress does not move faster to shore up the economy.

"We had an economic Pearl Harbor hit," he said ... "For a couple of weeks we've been arguing about who's at fault [and] fooling around while things have gotten a lot worse." ...

"It will cost more to solve this problem today than it did two weeks ago," said Buffett...

But he described a plan he thought of Thursday morning on the way to the Summit that would allow Treasury and private investors to buy assets together. He said his proposal would kickstart demand for mortgage-backed securities, help find a market price for these troubled assets and make it more likely that taxpayers would be made whole or even come out ahead in the bailout.

Under Buffett's plan, Treasury would lend hedge funds, Wall Street firms or any other investors 80% of the price for distressed assets. Investors would benefit from borrowing at lower rates available to the Treasury. But the government would get first claim on the sale of those assets, which means it would get its loan back plus interest and possibly turn a profit. Only then would investors see a penny.

"Now you have someone with 20% skin in the game," explained Buffett. "Believe me, I won't be overpaying if I'm buying with that kind of leverage. And you have someone [the investors] to manage the assets to the extent they need to be managed."

Buffett also noted that the presence of the government in the transactions would raise the price of assets above the absolute firesale levels for which they could now be sold. That would benefit the banks trying to unload them. ...

He said the [financial] problem boils down to widely-held assumption during the housing boom that prices could only go up.

Under this scenario, the private investors would benefit by being able to borrow at ultra-low interest rates that normally only the government can get. They could also get higher potential returns by having higher leverage. Meanwhile, taxpayers are protected because the private investors would take a 100% loss before the government lost a penny. This gives the private investors a very strong incentive to protect taxpayers from a loss.

The Economist: Bailout "deserves support"

The Economist endorses the bailout:

No government bail-out of the banking system was ever going to be pretty. This one deserves support.

Saving the world is a thankless task. The only thing beyond dispute in the $700 billion plan of Hank Paulson, the treasury secretary, and Ben Bernanke, chairman of the Federal Reserve, to stem the financial crisis is that everyone can find something in it to dislike. The left accuses it of ripping off taxpayers to save Wall Street, the right damns it as socialism; economists disparage its technicalities, political scientists its sweeping powers. ...

Spending a sum of money that could buy you a war in Iraq should not come easily; and the notion of any bail-out is deeply troubling to any self-respecting capitalist. Against that stand two overriding arguments. First this is a plan that could work (see article). And, second, the potential costs of producing nothing, or too little too slowly, include a financial collapse and a deep recession spilling across the world: those far outweigh any plausible estimate of the bail-out’s cost. ...

Mr Paulson’s plan relies on buying vast amounts of toxic securities. The theory is that in any auction a huge buyer like the federal government would end up paying more than today’s prices, temporarily depressed by the scarcity of buyers, and still buy the loans cheaply enough to reflect the high chance of a default. That would help recapitalise some banks—which could also set less capital aside against a cleaner balance sheet. And by creating credible, transparent prices, it would at last encourage investors to come in and repair the financial system...

The economics behind this is sound. Government support to the banking system can break the cycle of panic and pessimism that threatens to suck the economy into deep recession. Intervention may help taxpayers, because they are also employees and consumers. Although $700 billion is a lot—about 6% of GDP—some of it will be earned back and it is small compared with the 16% of GDP that banking crises typically swallow...

Mr Paulson’s plan is not perfect. But it is good enough and it is the plan on offer. The prospect of its failure sent credit markets once again veering towards the abyss. Congress should pass it—and soon.

Larry Summers on TARP

Larry Summers, Harvard economist and former U.S. Treasury Secretary under Bill Clinton, gives his thoughts on the proposed bailout:

It is necessary to consider the impact of the bail-out and the conditions necessitating it on federal budget policy. The idea seems to have taken hold in recent days that because of the unfortunate need to bail out the financial sector, the nation will have to scale back its aspirations in other areas such as healthcare, energy, education and tax relief. This is more wrong than right. We have here the unusual case where economic analysis actually suggests that dismal conclusions are unwarranted and the events of the last weeks suggest that for the near term, government should do more, not less.

First, note that there is a major difference between a $700bn (€479bn, £380bn) programme to support the financial sector and $700bn in new outlays. No one is contemplating that the $700bn will simply be given away. All of its proposed uses involve either purchasing assets, buying equity in financial institutions or making loans that earn interest. Just as a family that goes on a $500,000 vacation is $500,000 poorer but a family that buys a $500,000 home is only poorer if it overpays, the impact of the $700bn programme on the fiscal position depends on how it is deployed and how the economy performs.

The American experience with financial support programmes is somewhat encouraging. The Chrysler bail-out, President Bill Clinton’s emergency loans to Mexico, and the Depression-era support programmes for housing and financial sectors all ultimately made profits for taxpayers. ...

Second, the usual concern about government budget deficits is that the need for government bonds to be held by investors will crowd out other, more productive, investments or force greater dependence on foreign suppliers of capital. To the extent that the government purchases assets such as mortgage-backed securities with increased issuance of government debt, there is no such effect.

Third, since Keynes we have recognised that it is appropriate to allow government deficits to rise as the economy turns down if there is also a commitment to reduce deficits in good times. ...

Indeed, in the current circumstances the case for fiscal stimulus — policy actions that increase short-term deficits — is stronger than at any time in my professional lifetime.

Whitney says TARP would be a loser for taxpayers

Oppenheimer star analyst Meredith Whitney says taxpayers would lose money with TARP:

Taxpayers will lose money in the $700 billion government rescue plan for the nation's banking system, Oppenheimer analyst Meredith Whitney said.

Contrary to predictions from some supporters of the bailout plan, Whitney said on CNBC that the continued slump in housing prices will make a profit from the bailout unlikely.

"I think you definitely lose money on this $700 billion structure," Whitney said. "There's no idea where house prices bottom, and as a result how can you make money on this transaction?"

She said home ownership rates are still too high at about 69 percent and need to fall below 66 percent as more subprime mortgages given to less-qualified borrowers unwind.

We should put Meredith Whitney and Warren Buffett in an octagon and have them fight over this thing.