Sorkin and the Wrong Way to think of the Recovery

This, from Andrew Ross Sorkin, is a wrong way to think about the financial bailouts and recovery:

Imagine the Bailouts Are Working…Every couple of months the Treasury Department takes a moment to strategically leak some good news about the bailouts. It happened again on Monday, when a Treasury official told The Wall Street Journal that America’s coffers would be only $89 billion lighter after all accounts were settled from the rescues, down from an earlier estimate of $250 billion.

It’s enough to make us all feel rich, isn’t it?

Inside the Obama administration, there are whispers of even greater optimism, with some officials suggesting that if the economic recovery continues apace, the bailout program could eventually turn from red to black.

TARP and much of the other money lent in the financial crisis has been paid back. I think it is important to remember that Fannie and Freddie’s losses are in part the effect of a shadow bailout on the biggest players. However AIG is looking better. So the financial crisis cost us nothing as taxpayers?

At a high level, and an important level, this is a bad way to think of the question. As Simon Johnson argues, the real cost of the financial crisis will be an increase in government debt of around 40 percentage points of GDP. James Kwak does some math here: “The 2008 CBO report projected that by 2018, debt held by the public would be only 22.6% of GDP. The 2009 report projects 67.0%, for an increase of 44.4 percentage points..What happened between those reports? The financial crisis and a severe recession. And if we want to prevent that from happening again, we need to reform our financial system.”

Let’s take a look at a simple slice of those automatic stabilizers, regular (not extended) benefits paid out in unemployment insurance:

The financial sector isn’t going to be paying that back. We are. I think it’s really dangerous to argue that since the financial sector paid back TARP, and even AIG might even pay us back, we can assume everything is fine. It’s not. The collapse of the financial sector has put a massive strain on our finances and debt load. (As someone once told me, the only things that really destroy a country’s balance sheet are a war and/or a financial crisis. We’ve had a bunch of both lately.) It makes getting the financial reform correct, because it would be very difficult to do this against in 6-8 years.

And as for the real question from last spring: would having put some of the banks into receivership last spring been worse in the short term, but better in the long run? Would it have been more equitable, less of an increase in the concentration at the top of the financial sector? Even better for taxpayers than what we currently have? And would it put into place a system that wasn’t looking to replicate the banking sector of 2007 going forward? The answer to these aren’t obvious, but they are incredibly important.

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2 Responses to Sorkin and the Wrong Way to think of the Recovery

  1. Basle says:

    The real cost of the crisis is not to be measured in economic but in human terms. I am talking about jobs lost and the likely consequences: loss of medical insurance, loss of a home, loss of self-respect leading sometimes to a divorce! That’s rough! All of that due to a few greedy Wall Streeters who had no clue as to the way the economy works – see how Hank Paulson felt naked (and stupid) when faced with the crisis. He had no idea where it came from and even less where it was going.
    Let’s be clear: Wall Streeters (Goldman Sachs included) are no smarter than other people working in different fields (as or more important to the economy) and making a lot less money. They built an image but are thieves for the most part (I know I used to work for Citibank New York – Glad to have retired in 1996!). JLB

  2. Anjon Roy says:

    I really like this post because it pulls the “layers of the onion” or “concentric circles” on how to assess the damage of the financial collapse and the financial sector contribution (or negative contribution) to the broader economy. The total cost may depend on how wide of a lens is used when assessing the damge.

    As Sorkin and many financial media commentators from CNBC like to note, the cost of the TARP may actually be quite modest. However, TARP is also the narrowest measure of the total cost of the financial crisis and the financial sector in general. A 2nd, less narrow measure would include the portion of the GSE bailouts that ended up being backdoor bailouts to the shadow banking system. The 3rd level would be the cost of the various explicit and implicit guarantees provided to the commercial banking and shadow banking systems particularly after the remaining broker-dealers became Bank Holding companies and gained access to those government support mechanisms. By the 4th level, one could start to look at the actual mechanism that the banks used to “earn their way back to health”. For instance, one would have to look at the “cost of intermediation”, which would include the spread that the intermediary is extracting beyond what is historically typical, between the cost of its own funds (near free deposits or near free Fed discount window) and the price it charges to those it provides credit to (very high price for anything without a gov. guarantee, risk free profits for anything with a guarantee). Items like “fee income” might be included here too. For instance, if a bank’s “earnings” are generated by substantial fee income/ credit card charges or by inordinate intermediation costs (spreads), that would indicate that its earnings are not a reflection of the value it is providing to its buyers and suppliers (aka the broader economy), but rather, it is reflective of the value it is extracting from the broader economy. Related to this 4th level, one could include proprietary trading income that the Volcker rule attempts to end, as free or near free government backed funds are used to invest in assets and not used to lend to the broader economy. This is less of an explicit “cost”, but more of an un-egalitarian “ill gotten gain”. Of course, to the extent that this government backed trading creates potential future asset bubbles, that could certainly lead to explicit costs. That of course brings us to the 6th level, which you pointed out so well in this post; the cost of the financial disruption on the broader economy in terms of unemployment, lost economic growth, huge shortfall in government revenue leading to massive deficits, etc etc.
    At a 7th level, one could start to include indirect costs even beyond the recession to those costs apparent during “normal” times of having an overly financialized economy, where the finance sector accounts for 40% of all corporate profits. The 40% profits may not only be indicative of high intermediation costs that the broader economy is bearing, but it may also be a “resource vacuum” where the best and the brightest work for Wall Street, and not the “real economy”. Estimating the cost of this 7th level may be the most difficult, but is quite critical, as it leads to a broader philosophical questions on the true value of the financial sector.
    Now, the receivership debate from the fall of 2009 may not have touched on all of these levels, but it certainly touches on many of them. For instance, if the large, insolvent banks were put into receivership, at a minimum, those costs from levels 3 and 4 could have flowed back to the tax payer. Instead of a mere $89B cost, the tax payer may even have received a profit, perhaps a substantial one. Moreover, the potential of a long-term return (level 7) to an over-financialized economy would also have been at least partially mitigated.

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