When Economics and Politics Collide

I talked to a large number of economists in the wake of Congress’s decision to trash the (heavily revised) bailout plan. Responses — from those on both the left and the right — ranged from anger to bewilderment to frustration at what is quite clearly cheap election-year politicking on an issue that should be bigger than re-election.

Here’s a particularly pointed exchange in which a fellow economist wrote to a congressman, attempting to change these political calculations:

I made a donation to Congressman Grijalva‘s campaign earlier this year, at a house party. After hearing that Congressman Grijalva voted against the bailout, I would like my money back. This was a time to make a courageous vote; one that was in the best interests of the Congressman’s constituents, even if many didn’t realize it. If a member from a safe district like yours can’t be counted on to show leadership and do the right thing, it’s no wonder that someone like Giffords (my rep, for whom I will now not vote) wouldn’t. The stakes are way too high for this stuff.

Please return my contribution. … Please also take me off your mailing list, as I won’t be interested in supporting Congressman Grijalva in the future.

If you have any doubts about whether Congress’s rejection of the bailout was cold re-election politics, Nate Silver’s very careful analysis of the Congressional vote is well worth reading. Of the 38 congressmen in close re-election races, 30 voted against the rescue plan.

Excluding these highly politicized representatives, the vote was basically even: 197 for to 198 against. And of the 26 congressmen who are retiring (and hence are unswayed by the electoral math), all but a handful voted for the bill. (More from the W.S.J.’s June Kronholz, here.)

Yesterday’s dramatic decline in the value of the stocks — and hence in retirement savings — is probably the best hope that’s out there for changing these political calculations.

Unfortunately, I get to claim prescience on this one. Here’s what I wrote yesterday:

Markets are not reassured. … I don’t think that the problem is the revised plan, but rather fear that political posturing means that we are still some distance from the bill being passed in its current form. … The biggest risk appears to be populist Republicans in the Congress.

Both of the presidential candidates seem to understand the importance of getting some sort of rescue package put together (even if they were a little late in arriving at that conclusion). This yields a serious political economy question: What is it about the electoral math that leads Congressional representatives to calculations that are so different from those of the presidential candidates?

The good news: Intrade suggests there is about a four-in-five chance that a rescue package will occur in the next month.

On a lighter note, the new New York Times blog Economix (run by the always-excellent David Leonhardt and Catherine Rampell) has the results of an excellent competition to name the rescue package. I like the Blighted Asset Relief Fund (B.A.R.F.), but you can see the shortlist here.


Solutions to Sarah and Hilda, get more people in congress (legislation)/government (administration) more economists!!! that way the problems pointed out will be solved? no? on a little note, im glad that our presentation (CMS Econ class) of governement inefficiency had quite an inpact to you guys. (despite my terrible presentation.)

To conclude, congress/govt should get more economists or economists advisors as part of their team if they have not yet done so. ALthough, i think this is rather weak point. H.E. Paulson is an economist, and many of the congressmen/govt officers are company workers (CEOs), therefore, are economsits or must have a LOT of knowledge on econ stuff. I wish and do hope what peke said is true about congressmen, but sadly, humans are irrational.


To be honest, in my opinion there shouldn't be a government, probably the world could be better run by economists. I have never understood the decisions that governmets make, they only seem to favor themselves, and always are "trying" to make the country better off. But if it is totatlly necessary to keep the government, I must agree with Hilda, this probably has much to do with people having such a negative image towards economists, they can't see that this actually to help them. People always seem to trust the government's choices as been the correct ones, or at least the most convenient one. But the truth is that behind every decision that is made, much corruption is happening, and most probably this will never change. Unless economists take over the governments. :P


"Of the 38 congressmen in close re-election races, 30 voted against the rescue plan."

Why is this being presented as a scandal? Isn't the real scandal the congressmen who are not in close re-election races and therefore act more boldly against the known preferences of the people they were elected to represent?


Here's what my letter would say:

Best Case:

Nothing is done. Banks, afraid to lend to eachother and faced with watching their assets depreciate, loan to good borrowers with higher down payments or collateral and lower interest rates. Portions of loans with 6% or higher interest rates are refinanced at a lower rate, probably around 4%, on the existing value of the house or other collateral, the owner must pay the portion of the principal not covered by the current value of the house at existing terms, but the current rate is locked in. Owners deemed too risky at the new low rates default. Some banks holding mortgage backed securities that are dependant on the cash flows on the portion of the loan refinanced and on defaulted loans go bust. The assets of failed banks are sold off and the debts are nationalized. Inflation is kept in check, so costs of living do not increase relative to income, so default risk goes down. Commodity production increases to take advantage of recent rises in prices, continuously rolled over long positions on commodities are seen as untenable long term investments. Money is moved away from commodities, and prices of consumables fall. Default risk further decreases and some risky assets become valuable again.

Worst Case:

Bailout happens. Inflation increases, but home values continue to decline and wages remain flat. Home owners, with budgets already crunched beyond expectations, are burdened with even higher costs of living and default risk increases greatly. Defaults increase and home prices fall more. The bailout causes the interest rate the government borrows at to go up, moving money away from businesses and causes banks to expect higher interest rates from home buyers, putting further downward pressure on home prices. Scared money also goes from home and business loan to continuously rolled over long positions on commodities, which people expect production do not to increase for but demand to remain. Prices go up relative to income, and default risk goes up...

Credit markets freeze up within the next week and many businesses cannot meet their payrolls. Margin calls cannot be met and the NYSE shuts down for a week. Hardly anyone can get a mortgage so most home prices end up undefined rather than low. There is an emergency de facto nationalization of banks to keep the payments system moving... There is no one to buy up the busted hedge funds, so government and the taxpayer end up holding the bag. The quasi-nationalized banks are asked to serve political ends and it proves hard to recapitalize them in private hands. In the very worst case scenario, the Chinese bubble bursts too.


Measure for Measure

"If you have any doubts about whether Congress’s rejection of the bailout was cold re-election politics, Nate Silver’s very careful analysis of the Congressional vote is well worth reading. Of the 38 congressmen in close re-election races, 30 voted against the rescue plan."

Heh. I liked the NYT's graphic better.

Of those in safe Democratic seats, 38% voted down the bailout. But among safe Republican seats over 2/3 (69%) voted against the measure.

That last figure exceeds the share of tossup seats (59%) that voted the measure down.

I'd say that ideology carried the day, with the Republican party having fewer sane centrists than the Democrats.

Punditus Maximus

Does anyone else here feel echoes of the Iraq War? "A vote against this war is a vote against defending ourselves ever." "A vote against this bailout is a vote against any policy to deal with the crisis ever."


DJH (#36) "Second, this deal was NOT blocked by “House Republicans.” ... numerically speaking, they were utterly incapable of stopping this deal on their own. They needed help from some Democrats, and got it."

Most Dems voted for this bailout, most Republicans voted against it. If even half of house Republicans had voted for it, it would have passed (with the 140 Dem votes it received). So it's not so unfair to say the House Republicans blocked it - or would you blame the Dems for anything short of unanimous support for the bill?


Economist are generally great at predicting market failures. Ask any of us who have studied Econ, and we'll tell you one of the first things we learned (tongue in cheek of course) is that economist have successfully predicted nine of the last five recessions.


"I get to claim prescience on this one"

No, you don't. You said "Excluding these highly politicized representatives, the vote was basically even: 197 for to 198 against."

That's a pretty good indications that it wasn't very politicized.

"What is it about the electoral math that leads Congressional representatives to calculations that are so different from those of the presidential candidates?"

If the presidential candidates opposed it, they'd need to show the public that they have an alternative. Neither is prepared to propose something that will fail. They'd rather have the issue go away. Supporting the bailout is the politically safe thing to do.

Paul K

#40 (Josh), the technical accounting is conservative by nature. This means that a loan with unknown likelihood of full payoff should be treated as almost worthless - you discount all risk. Companies cannot use concepts like assuming upside potential based on housing market recovery in their accounting - they can in other ways and obviously did, but not in assets valuation. The Gov is buying these based on the idea that if they pay less than face value and more than foreclosure value (pennies on the dollar), then they prop up the financial markets so that less risky ones retain value and many of the purchased ones will in fact show full value. If done right, the taxpayers will make a profit off those and have mitigated losses on the others - especially if many loans are renegotiated such that they stay solvent.


So, if I get what some have said here... is that the infusion of $700 billion will make these assets less risky. If they're less risky, then they're worth more, all else equal. But why should the government really do this? Why are they trying to make these assets worth more? Why not try to make other assets worth more?

Alex, San Francisco

The InTrade line is perhaps too optimistic; The American public has staked it's claim and set minds will reject all explanations to the contrary. The ultimate disdain for the "so called experts" bolster people in righteous ignorance. If ever I was to have faith in one thing it would be in the absolute certainty with which we refuse to defer our opinion to those who may be more educated and experienced. In other words: If I know one thing it's that I don't know much. I've read a lot over the past few days and the objective mind tells me that when all the mainstream politicians and academics agree on something we should best do it. Taking the nihilistic view that because you were jilted once (Iraq) the whole system should burn is suicidal, which would be fine if it didn't hurt more the people you love (trite but true). Anyone who believes the letter-from-100-economists justifies their position should re-read it because it doesn't say anything at all and could be used equally well to argue either position; And all the while the barn is burning. And the masses cheered.


David Thornley

What frightens me about this crisis is the possibility that there will be a bailout, and that executives and companies that did stupid, even financially suicidal, things, will feel vindicated. I don't want revenge. I want deterrence. I want business people talking for decades about the stupid decisions that have been made and their consequences. Then their successors will probably go do the same stupid things again, but by then we just might develop a way of discouraging such gambling.

What puzzles me about this crisis is that it was going eighteen months ago, and suddenly the Secretary of the Treasury shows up with a demand for $700 billion and carte blanche. This administration has demonstrated the ability to say things that turn out to be false, and make tremendous mistakes as a consequence. The media has demonstrated its willingness to drum up action, for no other reason than it sells newspapers.

I want to make sure this bailout is carefully considered, and that, if it is done, it is done right. The risk of some delay is less than the risk of doing something irredeemably stupid.



Dr. Wolfers, unless I am mistaken, you signed a petition urging congress not to pass the bill. Please explain your new position and how it relates to your earlier position.


"they (unlike the gov) have to write them down based on present value, which is very low when risky, so we are back to square one."

Explain please why the technical accounting really matters here...will cash flow not be the same either way? What is really different about the loan just because accounting rules say that the government doesn't have to write it down?


#9 wrote: "The problem is that the average voter thinks this is just going into the pockets of the CEOs and Wall Street “fat cats”".

Actually this is exactly what I am thinking and they should work harder explaining to me why we should support the bailout. Actually I don't think that all 700 billion will go to the big boys' pockets, but I am sure that a substantial part of it will. Why on earth should the greed be rewarded with more money?


The NYT is very quiet today about what is going on with the hedge funds today. It's one of the four windows investors have to take their money and run if they are really scared. I suspect, that the Masters of the Universe are not scared and know opportunity waits when the rabbits bolt. My IRAs took a small hit yesterday compared to the slump of the last year. I'll hold firm and keep my cash reserves on hand to pounce on the frightened prey. Lets see tomorrow how many hedge funds collapsed today.


Professor Wolfers,

I'm confused. You signed a petition against the expedient passing of this bill on September 25th (http://weblogs.baltimoresun.com/business/hancock/blog/2008/09/hopkins_economists_against_the.html)and here you're upset that it wasn't passed? What is your actual stance on this bill? Should it have been passed or shouldn't it have been?

Rich K.

So, the argument is, credit is drying up and this bailout would've solved the credit problem? Where is the credit problem? According to the following Washington Post article, "outstanding bank loans declined 0.5 percent from the last week of August to the second week of September, though it was up more than 6 percent from the corresponding time last year."


In other words, available credit has actually increased from a year ago! Isn't that the exact opposite of what everyone is saying? Yet because no one in their right mind (other than apparently Bush, Pelosi, Frank, Paulson, Wolfers, etc...) wants to buy into high risk mortgage securities or the companies that hold them, credit for everyone else is going to be impaired? Where is the proof? Until I see some empirical proof that credit truly is drying up, to me it just seems like a bunch of chicken littles fretting that no one will buy into broken businesses.

It's like everyone screaming about what a threat Saddam and his WMDs are. How'd that work out again?

"There's an old saying in Tennessee — I know it's in Texas, probably in Tennessee — that says, fool me once, shame on — shame on you. Fool me — you can't get fooled again."



There are so many problems here, I have no idea where to begin.

First, a week ago economists were advising AGAINST rushing into anything. This was only the first Congressional vote in either chamber on any bailout package. If that isn't the "caution" that had been called for last week, what is?

Second, this deal was NOT blocked by "House Republicans." It was blocked by a combination of House Republicans and House Democrats. The most vocal opponents of the deal were House Republicans, yes ... but numerically speaking, they were utterly incapable of stopping this deal on their own. They needed help from some Democrats, and got it.

Third, the bailout is (it is claimed) needed because the credit market is locking up. It's locking up because the the credit market issued questionable mortgages and traded securities in said mortgages. It's going to remain locked up until the government -- or more correctly the taxpayer -- infuses money into it. Giving in to this demand will only incentivize the credit market to lock itself up again in the future, not only when it gets into trouble but any time it decides it wants more money.

Fourth, we keep hearing how this bailout will cost $700 billion, but we also keep hearing that the expenditure will not actually turn out to be $700 billion. Huh? If Congress authorizes a $700 billion expenditure, then $700 billion will be spent. That's how government works. Even if some value on the "toxic assets" is recovered, said money WILL BE SPENT ... somehow, some way, somwhere, someday. Count on it.