Economists on McCain

There are a few economists on the web who I read regularly (yes, I am that nerdy) and respect as being rational and not too rabidly partisan within the sphere of their expertise. One of them is Brad Delong. Here's his (edited) take on the McCain plan:

John McCain's New Mortgage Plan Is Worse than I Had Imagined Possibly, Even Given What I Know About John McCain

For the past month the debate about how to deal with the collapse of the debt-trading portion of America's financial markets has been between two plans: the Paulson plan and the Elmendorf plan:

• The Paulson Plan: Have the government buy up distressed securities at market value, thus reducing the supply of high-yield debt securities that the private sector must hold. When you reduce the supply of anything you raise its price. Hence the Paulson plan's $700 billion purchases will push the prices of risky debt securities up, and so companies will then be able to sell their bonds again and so hire more workers, and depression will be averted.

• The Elmendorf Plan: Have the government directly invest in and take an equity stake in troubled banks, thus reassuring their depositors and creditors that they are sound. The banks will then be able to profit by buying up distressed securities--hence raising their prices--and by directly lending to companies that will then be able to hire more workers, and depression will be averted.

The argument for the Paulson plan was that the Elmendorf plan was socialism.

The argument for the Elmendorf plan was that it held the promise of doing a much better job of preventing depression, for each dollar committed to the Paulson plan reduces the gap between the demand and supply of distressed securities by only $1, while each dollar invested in a bank is then leveraged 8-to-1 as bank creditors and depositors are then willing to keep more money in the bank and so reduces the gap between the demand and supply of distressed securities by $8. Eight times as much bang for each federal buck, and the Elmendorf plan ensured that the taxpayers were protected to a greater extent: we did not just have the socialization of loss after the privatization of gain, we had the socialization of any gains that might occur if banks' equity values ever recovered.

Now comes John McCain with something worse than Paulson:

Details provided to reporters by senior adviser Doug Holtz-Eakin Wednesday morning make one thing clear: Taxpayers would directly pick up the tab for the difference in cost between a homeowner’s old, too-expensive mortgage and the cheaper one provided by the government... something that congressional lawmakers, led by House Financial Services Chairman Barney Frank (D-Mass.) specifically avoided when they crafted their own landmark housing bill, which passed in late August and took effect Oct. 1.

Congress’ bill – which Holtz-Eakin says provides at least part of the authority McCain would need to carry out his plan – provided a $300 billion program to help distressed borrowers refinance into cheaper Federal Housing Authority mortgages. But to participate, lenders and mortgage investors would have to reduce the mortgage principal...

Not so McCain's plan. McCain's plan is for the government to buy up $300 billion of distressed mortgages not at current market value but at full face value [...] The McCain plan is:

• Take $300 billion.
• Pay double current market value to banks that have troubled mortgages on their books, thus:
  • Give a present of $100 billion to the bankers who made the loans.
  • Acquire and regularize the mortgages of only two-thirds as many homeowners as could have been accomplished if the $300 billion were invested wisely.

There's a big difference here: Democrats want to prevent depression and support the financial markets by investing taxpayer money in banks with troubled assets. Republicans want to give taxpayers money away to the shareholders and managers of banks with troubled assets.

The NYT's Krugman adds an interesting tidbit to essentially the same take:

Readers ask what I think should be done about the financial crisis. The answer is, what Gordon Brown in doing in Britain: a bailout, yes, but one that gives the government an ownership stake in the bailed-out institutions. That plus a serious fiscal stimulus plan that includes emergency aid to state and local government.

The Brown plan, by the way, is 50 billion pounds; scaled by GDP, that would be the equivalent of a $500 billion plan here. The headline number would be smaller than the Paulson plan, but the probable effectiveness much, much greater. Not so incidentally, my reading of the TARP as passed is that thanks to the equity participation provisions, it could be converted into a version of the Brown plan at the Treasury secretary’s discretion; let’s hope that he does so discrete, or something like that, as soon as possible.

Which is to say that apparently, without the bank lobby realizing it, the $700 Bn bill that was signed into law had a clause added which gives the Secretary the option of buying stock instead of buying the assets. This is fascinating, since that had been advocated as an option and the banking lobby was bitterly opposed to it and supposedly had killed that clause, but it got added back in at the last minute, and due to the massive scale and complexity of the final bill, nobody outside congress noticed till it was already passed.

Given that Paulson has a banking background and something of a pro-bank bias, it's not clear to what degree if at all he will exercise this option. He was willing to nationalize AIG, though, which implies he might well decide that it would be in the taxpayers' interest to own stock rather than shitty assets. Who knows?