Thursday, February 19, 2009

Stimulus vs. bank bailout

Someone asked me today what I thought about the stimulus package. I said I thought there needed to be some kind of stimulus package, but that this is different from the bank bailout, which is being managed by the Treasury Department. The two are frequently confused.

The stimulus package, being a product of Congress, is a mixed bag of give-aways to various constituencies, as one would expect from that process. The overall point is to encourage spending. Many economists warn that the stimulus is not big enough to adequately do this, however, given the scale of the recession.

But the real problem lies with the banking system. Banks have accumulated large quantities of bad debt that nobody knows how to value. The government's approach so far as been to let bankers prescribe their own medicine -- namely, writing enormous checks to themselves at taxpayer expense. While this has kept bank managers employed at compensation levels which they endorse, it has not led to the kind of lending activity necessary for economic recovery.

Obama's economic team, most of whom hail from Wall Street, have argued against bank nationalization (direct government takeover that would wipe out bad assets and permit wholesale restructuring ) mainly on ideological grounds that governments do not make good bankers. But that argument has become increasingly untenable in the face of continued private sector failures, with even the likes of Alan Greenspan acknowledging the likely necessity of such a move.

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