Angry Bair

Sheila Bair, who ran the FDIC during the crisis, argues against further bank bailouts. She earned great respect. One thing, which she doesn’t mention, is that she refused to let Geithner use the FDIC trust fund to bear the lower tail risk while leaving the upper tail profits to investors in Public Private Investment Partnerships. She insisted on having a veto on non-recourse FDIC loans used to purchase newly made pools of iffy mortgages. As a result, the prediction by Paul Krugman and Joe Stiglitz that the program was a scam turned out to be incorrect, while my prediction turned out to be correct.

Nonetheless I partially disagree with her firm op-ed. Oddly, the point is that it completely neglects the accomplishment of people like Sheila Bair (there may be only one of them). In her column she doesn’t mention the fact that the US Federal Government made a huge profit bailing out the financial system. The careless reader might imagine that the bailout consisted of grants and that the national debt was increased by the amount disbursed not reduced.

This isn’t key to her conclusion that such generous bailouts should be forbidden and that the Dodd-Frank act which requires that future interventions be more painful for bankers should be preserved. Her valid point is that the crisis caused huge losses, even though the bailout added less than nothing to those losses. She argues that planning future bailouts with profit for the US government but not enough pain for the bankers would create moral hazard. I absolutely agree.

But it is also a fact that the US government made huge profits (I think the hugest in world history). The moral hazard argument is valid and can stand totally aside from the insinuation that the bailouts cost taxpayers anything.

I think this is important, because since public onwnership of risky assets bought at higher than market clearing prices to save the financial system was profitable by accident, we must know there is a gigantic inefficiency. I think the reasonable response is to sell bonds and buy risky assets for market prices. That means that the profitability of the bailout is strong evidence that there should be partial public ownership of the means of production.

This was noted by John Quiggin decades ago (arguing against privatizing state owned firms in Australia). It has been argued by Miles Kimball for years. A little bird told me that Olivier Blanchard talked about it over lunch with Brad DeLong recently.

I think it is an important part of the lesson of 2008 (I admit I have been advocating it since 2005).

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