Economists and Bailouts: Mea Culpa

I wrote yesterday about my dismay at the failure of Congress to pass the revised rescue package. It is time for economists to own our share of the blame.

We have failed to explain in clear language just what it is that credit markets do, and hence why it is so important that we fix them. (Dani Rodrik agrees.) This failure is all the greater, given the public’s understandable cynicism about Wall Street, the government, and economics. Our failure helps explain why Congressional populists believe that opposing the rescue plan will help their re-election prospects.

I am truly, deeply sorry we failed. Truly. But it’s not too late to remedy the situation. Here’s my first attempt, voiced in a piece on American Public Media’s Marketplace program last night (listen here):

The financial system does something pretty amazing: it converts your savings into productive capital. It’s a bridge between borrowers and lenders. When it works, it’s a beautiful thing: your savings are redirected to help young couples buy houses, entrepreneurs turn ideas into innovations, and employers invest in their workers. … Today’s problem is that the bridge between borrowers and lenders has been washed away. Think of the bailout as infrastructure investment. We need to rebuild that bridge.

In fact, the financial system is so important that the Wall Street whizzes can get insanely rich by taking even just a small sliver of the gains the system generates. And this is part of the problem: these exorbitant pay scales have yielded a pretty raw — and understandable — desire for revenge against the folks who got us into this mess (see the comments thread, here).

But the demand for revenge respects the usual laws of economics: the public wants revenge (refusing the bailout) when it thinks it is cheap. Revenge is in much less demand when it is expensive. (Dan Ariely has more.) My fear is that we have done a poor job in explaining the costs of this revenge. If economists succeed in explaining the role of credit markets in our lives, an informed public can weigh its desire for revenge with the very serious economic consequences of doing nothing. An informed public will help lead Congress to better decisions.

Why have economists failed in our roles as educators? Solving the crisis is not simple, and we have been debating what to do, rather than making the case that we need to do something about these broken financial bridges (thanks to Alex Tabarrok for the metaphor). This debate has been quite useful: the revised rescue plan was much better than the original Paulson plan: we now have real oversight; clearly defined objectives; a chance for taxpayers to share in the gains; and a measured response to the public’s anger about bad C.E.O.’s earning big bucks.

But as Andrew Samwick noted, “Don’t all of us who insisted that Congress be involved and improve upon the Treasury Secretary’s initial proposal look stupid now.”

Related commentary: David Leonhardt; Martin Wolf; Jonah Gelbach; Free Exchange.

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  1. Tyler says:

    This is the largest problem–the public doesn’t understand what this bill does, or how credit markets work. Hopefully articles like these can help.

    It frustrates me to no end that the average blue-collar American thinks this is money coming out of his pocket and into a multi-millionaire Wall St executive. The fact that he pays a sliver of his true share of federal taxes notwithstanding, the media and government have failed if the bill is so misunderstood. Since many Congressmen care more about their popularity than doing the right thing, how can they make the right deicision when their constituants don’t understand the circumstances?

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  2. Zoinks says:

    New bridges will be built, Mr. Wolfers. Higher and stronger than the ones that are at the bottom of the river. Me, I’m not interested in trying to bail out the sunken bridges.

    Newlyweds will wait to buy houses, workers will wait to buy their cars, and entrepreneurs will need to stretch their imagination a little further to launch their businesses. They’ll wait until new suppliers for the demand for credit step in to make a profit. The GDP may likely experience negative growth, but on the plus side we as a country will not have taken out a home equity loan in order to pay our mortgage.

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  3. Paul K says:

    Justin, part of the problem in your simplistic description of the financial markets is that it ignores how much more complex that market has become since being deregulated 10 years ago.

    The traditional model of using deposits to make loans (banking) is only a tiny part of the money involved these days, and is not the cause of the mess we are in. Securitizing of loan packages, derivatives, default swaps, trading on default swaps, and all the other complexity that keeps the credit markets fueled with more money to riskier ventures (since they pay more interest) has made it too complex for most to understand. That coupled with the need to tap into dumber borrowers (who do not read the fine print or realize that they own nothing at the end of the day) to keep the interest flowing, has left a lot of people on Main St angry. They (rightly or wrongly) blame anyone involved since they or their friends and neighbors are getting foreclosed on, etc. So, they tend not to believe you or anyone else anymore.

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  4. Pat says:

    What snobbery. Perhaps you should consider economists did explain themselves just fine and the rest of us think you’re wrong. I understand you just fine but I think that the unintended consequences of rushed legislation, precedent for future Treasury gambles based on a crisis, overpaying for this junk, and worthless pork getting attached are worse than doing nothing.

    If only I’d have explained the truth better to the peasants…. Puh lease.

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  5. Ravi says:

    I don’t know if it’s right, but I think that the public perception is that the toll collectors on the bridge haven’t been happy just collecting their toll. They’ve also been cutting pieces out of the bridge with blowtorches, selling them for scrap metal, and bragging about their huge profits. Now the bridge has collapsed, and yes, it really does suck for all those people who can’t cross the bridge anymore. The toll collectors are saying, “Please build a new bridge, and we PROMISE we’ll take care of it THIS time if you leave us in charge!”

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  6. Tzipporah says:

    You’re setting up a false dichotomy, here. An informed public isn’t choosing between “revenge” (do nothing) and fixing the economy. A truly informed public is choosing between different proposals which address ALL the problems: fixing the immediate crisis, establishing regulations to restrict future problems, letting the market correct itself, and apportioning financial responsibility for the “fix” between taxpayers and interested parties (those risk-taking millionaires at the center of it).

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  7. Paul Gunn says:

    Has the possibility even occurred to you that you’re wrong? That the bailout is a high risk measure that has no guarantee of fixing the problem – that could indeed make the problem worse?

    Why are you not discussing / proposing other alternatives and possibly lower-risk options? For example suspending FAS157 which is a big contributer to the current banking panic.

    In summary, why don’t you discuss the issues and drop the paternalism. Your sorrow at failing to ‘educate the public’ looks to me like a thin mask for arrogance and vanity.

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  8. Dan G says:

    The biggest problem is actually the timing of this crisis. Had it not come so close to a decidedly partisan election year, it would likely have blown over by now. Politicians, however, are much like the celebrity news media: they love to gossip and rile up the fan base.

    My only hope is that election politics don’t defuse the work being done on the bailout plan.

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