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.

Jake Summers

Actually as an engineer the system appears to be working correctly. This is what occurs in fractional reserve systems of fiat. You can't fix something that isn't broken.

And of course how is this bailout going to keep main street from burning down to the ground? This looked like a bill designed to bailout Wall Street as main street falls into a depression caused by fractional reserve lending gone crazy. Who would be willing to lend when we have a massive overhang of debt all over society? This is especially true as people are forced to reduce consumption by lack of credit, lack of jobs, lack of everything.

The most likely situation is the banks will simply hold the capital. They won't lend and the state will have yet greater future obligations to repay. All the while the ability of Americans to repay as we go into a nasty recession become harder. After all free trade will not allow for wage increases any time soon, even in a severe recession. Is this the great equalizer of globalization? Are all Americans going to be equalized to global wages now?

What exactly are we missing that many of us didn't warn about years ago? Many of us savers saw our lives destroyed by the upward credit spending insanity and raised our hands. And now on the way down we take the fall. Thanks a lot for educating us that we must be stolen from yet again so the world doesn't burn down.

Why save in our corrupt society? You will only end up paying for everyone else's spending spree one way or the other.

As for the comments about the Fed raising interest rates they can't do that. It would only force out all the garbage sooner and we would quickly learn that our society as a whole is insolvent.

I can't wait for the economics "educators" to tell us how we should remove the minimum wage when things really heat up on Main Street.

So can any of you tell us based on your understanding how many people will become unemployed? For now I am guessing between 10 to 15 percent of the US. That is a speculative guess. Maybe it will be worse?

Of course it could be worse. We have heard the great depression being thrown around a lot. That would be around 25% which would be pretty hard times. It is interesting that without credit and the ability to roll it over on top of current bills how things fail. It simply shows that about 20% of society is always insolvent and survives not off their profits but off the credit creation mechanism of fractional reserve lending.

But we are of course totally uniformed citizens that don't understand. I do agree something should have been done. But this isn't it. I supported Nouriel Roubini's plan because he seemed to be the best balance that would yield the best results to cause the least amount of suffering.


Hughson, SA, Cape Town

The bottom line is our financial system is based on trust. Once you understand this you will know that no amount of money can ever buy trust. The more i look at is the more i become unconvinced that this bailout will work. We need to establish trust and that means politicians and leaders of financial as even spiritual world need to start convincing everyone that we can trust each other.

If one know how and why money works, one will come to one conclusion. The current ststem, just like all the other failed currency system such as gold standard, is doomed. We need to painfully start afresh.

Bill the Tall

Don't take on all that blame. Economists could have given a letter-perfect, Nobel-eligible explanation and rationale, but with the highest hurdle would still remain. The White House Occupant has lied and weasled and lied time and time again. He dragged the Senate along by the nose with cries of "the WMDs are there, the WMDs are there!" Then he screamed over and over, "Al Qaeda is there; Al Qaeda is there!" Then when it was time to advance medical science and American leadership in the field, he said "Unborn lumps of cells will die! Unborn lumps of cells will die!" Too many times, wishful thinking was treated as The Truth. Now, when The Truth needs to be told, Americans have grown too weary and, in fact, too angry.

So Economists, don't take the blame for what you have not been responsible for. Keep up the good work. Maybe improve your public relations a little, but don't give up.


David H.

This is obviously a partisan chop-up job, but take a look. These are video clips of Committee hearings, indicating the strong opposition by Democrats to regulating the government sponsored enterprises, specifically Freddie and Fannie. These may be somewhat out of context, so I urge you to look up the actual transcript from these hearings so we can figure out what was going on.

here is a New York Times article in 2004 citing this hearing:

here is the transcript from the Subcommitte Hearing on Wednesday Oct 6, 2004:

here is the prepared statement of William Lacy Clay calling the hearings a "political lynching" (notice the use of race to intimidate):

here is the transcript of the hearing of the Subcommittee on Housing and Community Opportunity on Thursday, Oct. 7, 2004:


Dave Jones

Even if we assume a bailout is needed, it does not mean that Monday's bailout was an acceptable one.

I admit not understanding the issues with the credit market. But, from what I understand of the original bill, there were not enough checks and balances. This is bigger than economics.


Over 100 economists signed the following statement:

"We ask Congress not to rush, to hold appropriate hearings, to carefully consider the right course of action, and to wisely determine the future of the financial industry and the U.S. economy for years to come."

Why have the contributors to this blog turned against an economists' consensus?


I think there's a clue in the phrase "too big to fail" that we aren't scrutinizing nearly enough.

Globalism produces unprecedented potential for gain, but it also puts us at proportional risk. Communist or Capitalist, governments are now in the position of underwriting risk. We need to stop right there and think long and hard about whether this is really the road we want to go down. I highly doubt this bailout will be the first time we are called upon to balance the corporate books at taxpayer expense.

If you bring the issue out of the abstract and closer to home, the global business model has brought us to a point where flu vaccines, Tamiflu, and entire classes of antibiotics, are manufactured by ONE source. An economic, political or natural disaster can mean mass shortages of certain medications, which, in turn, will make them even more costly than they already are. One day, what if those shortages included food? What if a severe economic crisis combined with even higher fuel prices means that truckers are temporarily, even, unable to receive a paycheck? Will every Walmart, grocery chain and retail store from one end of the country to the other suddenly be faced with bare shelves because a handful of trucking companies are idling down due to strike, natural disaster, political instability or economic crisis?

In a system that is efficient there are ever-fewer redundancies. This leaves fewer players in place to go on conducting "business as usual" in the event of a crisis of epic proportion. This means that the problems that used to effect one community — such as the gasoline shortages in the East following hurricane Ike — may become regional problems, then national shortages, then global shortages.

Isn't there something to be said for the idea that local communities should be self sustaining to whatever degree they can? For all the talk of going Green, does not this idea have equal, if not greater merit, at the economic level? This means that local banks are lending to local residents, not passing off risk to faceless investors half way around the world. This means that communities should have SOME capacity to grow their own food, meet minimum energy requirements, and sustain some semblance of manufacturing capacity.

Sure, it might be unrealistic for that to happen now. But it should be the long-term goal.

It was once believed with near religious devotion that the world was flat. That the Titanic was too big to sink. If there's one thing this economic crisis has taught us, it's that you can never say never.

The prospect of global recession is an inevitable byproduct of an economy that has become too enmeshed. Like a pair of young lovers joined at the hip, this is a relationship that might look ideal at first glance, but is psychologically dysfunctional. None of this is to say that international business is a thing to be shunned. It is only to say that global business should not should not come at the expense of local productiveness (sustainability).

I fear what will happen in the months and years to come because we've all but forgotten that what works in times of plenty, is too often foolhardy in times of need. There was a quaint maxim that held that you "don't hold all your eggs in one basket". But when key industries have absorbed and edged out virtually all of their competition, they leave those of us living on Main Street overly vulnerable to every economic shakedown, even those that occur half way around the world.

We wouldn't manufacture a rope with only one thread, for that would be better described as a string. You could say that with each merger, each death of a competitor, each transformation of a local economy into a consumer economy, we're taking a rope of many threads and reducing, cut by cut, it to just one. That sort of efficiency may reduce waste and redundancy, but it's also the source of our global economy's potential unraveling.

Maybe it's time to rethink basic assumptions. We're not talking religion, after all — or are we?



Two economists, three opinions.

Two petitions of economists, two opinions.

The profession is making progress, but still fails to make any difference when it matters.

(I originally posted this on Economix's post on the "counter petition")


Justin comments have now made me completely believe that matters of economy are too important to be left to economists. Further, his views on "public's inaction", supposedly, has an economist written all over it - looking down on every proposal that is outside of standard economic theory; they are always right and others are wrong and stupid.

If savings are so critical to the process of "rebuilding the bridge", why not not give $2500 to every American directly with the condition that this money would have to sit in an account for x amount of time with a guaranteed interest and in the mean time the economy can start using the money to do whatever it does with clear regulations. So in effect if main street is anyway lending money to main and wall street, then why not make this arrangement more explicit?

Or why is no economist proposing a direct way in which we can use the money to avoid foreclosures since falling home values and failure to pay the mortgage is what we are told is driving this whole crisis. Why not have an agency help the lender and borrower sit down and find a way to save the foreclosure?

In summary, all this involves a more creative, more egalitarian, more people-centered (whether Wall or Main street), and not institution centered, policies that requires going beyond what economists, except a few, can usually fathom.



Frankly, as an Economist (and former Portfolio Manager), I understand perfectly well how financial markets work and why they are important. And I firmly oppose the "Bailout" in it's proposed form.

The reason frequently given for not helping out struggling home owners last year when the crisis started to unravel, was one of moral hazard - if we help them out now, they will make the same mistakes again, and others will copy them.

I am surprised that Economist fail to point out that the Paulson plan introduces the same problem (of moral hazard), only on a much, much larger scale!

The only reason why we're even considering this plan is BECAUSE we know how important stable financial markets are for us - for businesses, our jobs, the real economy. So the failure of the financial system to do what it is supposed to do (to provide liquidity, distribute risks etc.), imposes huge external effects on the rest of us. Not just in the form of tax dollars but in the form of real economic losses.

In my opinion, a simple, classical Olsonian argument is all you need to see cristal clear what is going on: a group with homogenous interests that is well able to articulate their demands, as well as the consequences should we deny them: GLOBAL RECESSION. And because we know they can bring us all down, we're going to fold.

I think it is despicable that even credible Economists like yourselves fail to point this out. We should be the first line of defense of democracy, against the influence of groups that blatantly attempt to blackmail us into compliance. I am appalled by the lack of criticism from the profession, and by the lack of self-reflection.

Good luck, America.



Thank you, thank you, thank you Mr. Wolfers. Now I see the light!

Oh wait, not all economists agree that this was a good idea? I guess they "don't understand" either. Even if there are over 160 of them from universities like Harvard, Chicago, Berkeley and Stanford. Maybe they just need to have this explained to them.

See the letter and the list:

Ron Matthews


caleb Mardini

This isn't about revenge. It's a disasterous plan.

"An informed public will help lead Congress to better decisions."

Are we morons? Would you also say we cut off our noses to spite our face?

Our economy is in trouble we face a great pain regardless of what is done. The plan put forward is not an appropriate solution.

The question perhaps should be "why have the people failed in their roles as educators?" Or better yet, why do we read from people who distort our opinions through their own assumptions.

I'm sure some people are as you say, but the people I've been working with to halt this bailout are informed, we are aware of the consequences of this bill, and we are aware that there are many better alternative plans that have been put forward.

"we now have real oversight; clearly defined objectives; a chance for taxpayers to share in the gains;"

The oversight is token oversight. The objectives are lip-service, and whatever Paulson wants the objectives to be. The gains will be non existent.

#2 Zoinks is right, with New bridges will (and new bridges must) be built. Keeping proven failures in charge of our economy is not in our interest. Like "Women Who Love Too Much" this bill enables our abusers and prevents better institutions from coming into being.

#4 Pat is right, this is "Snobbery."

#5 Ravi, is right. Why trust them again?

#6 Tzipporah Is right. This you're setting up a false dichotomy. It's not about revenge. There is an informed public, who sees there is more to the problem and this bailout falls short.

#7 Paul Gunn is right. Drop the paternalism and vanity. I, and I'd say most all of your readers find you to be very intelligent. But this Mea Culpa, may have been in error.

#10 Kenney G "I question Wolfers assertion that this money would go into repairing the bridge between borrowers and lenders."

#14 Sanchmo is right. "The suspected false dilemna is that we have to choose between implementing the Paulson Plan immediately without debate, or a decade-long Great Depression with 25% unemployment." There are better alternatives.

#17 Steve is right, the bill was severely flawed.

#18 Joe Torben is right, Important questions are not being addressed, beyond your talk of credit markets.

#19 Rich K. brings up a good point regarding time.

#23 Rob brings up a good point you're asking for more of the same.

#38 Zvi just shows that that some would prefer a different form of relief.

#39 Eric brings up the point of how we are dealing with deflation and deleveraging. Sure we may see an easing of credit markets, but for how long? How sustainable is the debt party?

#46, Jerry M. "Why not reward those who are best poised to succeed them in the marketplace?"

#47 T is right, The bill isn't really fixing the issues.

#48 MFS, yup, there are other far better plans.

#50 RR "we just want a better bill." What's wrong with that?

#51 brings up a point, why are we attempting to prop up this faulty system? If we want to talk metaphors how about the legacy of fire prevention? Are you seeing the forest through the trees?

#54 brings up the point that we're going to be overpaying for things.

#59 Tom Harrington...are we due for a repeat? I think so. That's econ 101 isn't it?

#63 joseph "if you and the Hank believe in the need to buy junk - why dont you put your money where your mouth is ?" Indeed the premise of the plan leaves out the first actor that should have been considered, the markets themselves.



To DP (#67) --

Thanks, that was helpful. But what I take from your explanation is that supporters of the Paulson plan are hoping that people accept the price the government pays for these assets are the correct "market" price. If that is correct, then I'm not sure I'd want to put all my eggs in that basket. I don't see why we anyone would be more confident that the government can set the right price when the real market cannot. (Not that I have a better solution - I'm honestly just trying to understand how this is all supposed to work.)

To Hume (#81) --

I asked the same question a while back in this string and never saw an answer. I think it works something like this: banks do not always have cash on hand to pay withdrawals - they sometimes need short-term loans. If they cannot get those loans, they fail - they're insolvent. Right now, other banks are reluctant to make those short-term loans out of a fear that they won't have cash on hand (so they are charging very high interest rates). And banks are less willing to take steps that might further deplete their cash, like issue new loans (except at very high interest rates).

I encourage people to correct me if I'm getting this wrong.



First, I agree that there's been a significant lack of education on the subject going on, and a lot of hand waving and shrieking on both sides. Forget for the moment how we got here. It's immaterial to the problem at hand - we ARE here. Now, do we need to do something about it? Reasonable people can disagree about specific remedies, but here are a few plain and simple reasons why "tightening credit" between financial institutions matters to Joe public, and how "Wall Street fat cats" affect your money directly. (And, yeah, I don't need the econ gurus telling me it's too simplified, it's partly explanations like #38 Zvi's that make people distrust economists on this)

One - What happens to me if credit remains tight?

At its most basic level, lending between banks, et al, eventually affects your ability to get a loan. If banks are paying 15% interest for interbank loans, what its the probability that you will be able to get a loan for less? If you face a 16-20% interest rate, what is the probability that you will buy a home, or car, or any large ticket item requiring credit? Pretty low. So, a lot of construction jobs all go out the window. GM, Ford, and others suffer massive losses and lay off 80% of their employees. Steel and lumber businesses crash and burn. With unemployment at historic levels, then, who will buy computers, music, electronics? Our economy depends on a basic trust that goods are worth something - and people will buy them. Banks failing is just the beginning of a huge domino-like cascade. This is what has everyone in a tizzy, not some bad mortgages going into foreclosure.

Two - Aren't we giving money to crooks?

"Wall Street fat cats" are fat not because they manage their own money - but because they manage huge pools of money entrusted to them by masses of 'ordinary Joes' - including pension plans, Mutual Funds that are in all of your retirement portfolios, insurance companies, etc. One can argue another day about the executive compensation for those managers, but in the end, they wouldn't have a job if it weren't for managing your money - and it's YOUR portfolio that's going down in value. Think the baby boomers on the brink of retirement want to be subsisting on social security in their golden years? Do you? If we are in a serious economic crisis, will we be able to meet social security obligations at all?

Three - I don't have my money in WaMu - or in fancy credit derivatives - why should I care?

So, you don't have your money in WaMu, whew! Your money is safe in a regional bank... except it's not. And today it's not just in your neighbor's house loan, either. In order to make your money work harder (so that instead of charging you for depositing your paycheck the bank actually pays most depositors interest for it) your bank loans YOUR money to other people and banks, and also plays the market with it. (Yes, deposits are insured up to a point, but if the federal government has to come up with cash to pay out to even a fraction of all depositors, it will make that $700BB look like chump change - and at some point would seriously impair the credit of the entire US government.) So your bank's cash is spread around collecting interest from other people and institutions, but some of those other institutions can't make their payments. Now your bank has lost a lot of its assets. Poof! Your bank just folded. Get in the 10 mile long line to collect your FDIC insurance payout.

In short, what happens to Wall Street will affect you right in your wallet unless you've been cashing your paycheck and buying gold bricks to bury in your backyard. That paper stuff? It's value is determined by how sound people think US credit is.

Part of the credit 'drying up' is being caused by the uncertainty of what all of these complicated mortgage-related financial instruments are worth. Virtually overnight hardly anyone is buying, which means they're worth pennies on the dollar on the open market - even though MOST mortgages are sound. (This is also where that 'mark-to-market' rule has brought down institutions which were probably solvent.) So MOST mortgages are fine (and the mortgage-related securities) - they're not really worthless and the sellers know that, so they don't want to sell them at a huge discount. But not selling means that the institutions who are holding them don't have capital available to spend or to pay out to creditors (like your regional bank).

Part of what the Gov't buyout would be doing is establishing a generally accepted starting price which everyone could agree upon and which would start transactions going again. In addition, under the buyout, the Gov't would be buying loans - some bad, but even the sub-prime loans are mostly good - and, if held and then sold later, will put at least some of the money back, and in the best case scenario would actually be a windfall for the Gov't coffers - and by buying the loans, capital is infused into the system, stimulating credit and transactions.

Now, an alternative plan would be to just open the lending window at the treasury and offer low-interest rate loans with very low collateral requirements. Which might result in a similar outcome - repayment with interest to the Gov't, and a huge infusion of capital into the system. But it's still going to be hundreds of billions of dollars. (And yes, Treasury pulled that number out of their behinds - it's likely in that ballpark though, and they wanted to convey the seriousness of the situation with a fantastically huge number.)

Good people can disagree about what is the best 'plan' for achieving relief, and it's possible that the credit crunch will sort itself out. But given that there's a very real chance - some estimate as high as 50-50 - that it wont, and given that if it doesn't we could very well be looking at affecting the 'full faith and credit' of our entire nation (which would be a nightmare the likes of which I don't even want to contemplate) The risk of doing nothing is way too high. I don't want to roll the dice on our entire economy to punish some bad actors. Put those people in jail after this is stabilized. Even if the measure fails to achieve all it's hoped it will, at least we wont have been guilty of not trying. Further, this bomb has a ticking timer on it and no clock to tell us how close it's getting to going off.

# 51 - Kevin, we're prepared for a Depression? Really? You've got to be kidding. People have been gnashing teeth for years with a merely slow-growth economy. The word "recession" is enough to cause panic - and you think we're prepared for a depression? Who is this "we" you speak for?



Don't economists also have vested interests? Justin is speaking as if economists are only acting in a pure academic manner.

The arrogance by these "academic" economists is truly sad.

Lluis Tarrida

It is not the bailout, it is the certainty that the culprits will be unpunished.



The septic tanks sure have got to you. You are not only a toff but have such high tickets on yourself. Shonky businesses being bailed out by their mates. And Hank Paulson is the Wall Street version of a standover man. Credit markets are not within a cooee of collapsing. And if credit cards vanished - like a good wogboy - use cash.

Seriously, if you and the Hank believe in the need to buy junk - why dont you put your money where your mouth is ? Put down half your networth to buy it up. Or is it only the bogans that need to pony up? Stop being a sook and a wuss. Your mother wont be proud of you.

Moderators - lots of Australian slang - the blog author will understand. Hope you will let the comment stand.

Mark Freeman

I have been suprised by the lack of quantitative information in this whole debate. I have found information that shows the unprecedented rise in the interest rates banks are charging to each other (the TED spread). So I am convinced that there is probably an unprecedented (at least in recent times) credit crunch. But has any macroeconomist run a model connecting the inter-bank offer rate (the LIBOR) to broader measures of economic health. What does such analysis say about the likely impact on employment, GDP, etc? And can these models provide any insight into how much the proposed $750 billion might reduce the LIBOR, and subsequently improve broader measures of economic health? Do the models also allow us to weigh any potential short term benefits against any longer-term costs associated with increased federal defecits and/or taxes to pay for the $750 billion? It would be nice to have this kind of information (even if it was imprecise). I think a lot of us are justifiably worried that our government is committing a huge sum to a venture that we haven't taken the time to analyze. I wonder if we took the time to hold a few hearings, some of those Nobel-winning economists could address some of the questions I just posed.



Most of the posters who rail against the bailout underestimate the interconnections between all our financial services. The economists don't want to be alarmist because public confidence is an important part of this shell game we call an economy.

Try to imagine your life when every transaction must be paid for in cash. Then imagine that you can't go to the ATM to get more. Like it or not, we rely completely on trust in our financial institutions for our lifestyle. If that trust is at risk, then so is our lifestyle.