Thursday, August 30, 2007

Critique of Summers

This seems a reasonable criticism of Summers. Dean does by the way think that there should be some steps taken to help people who may lose their homes but not speculators as Summers bailout would seem to do. I assume Summers would claim that the bailout might serve to calm the markets and prevent even further stock losses and create confidence.

Summers Calls for Bailing Out the Wall Street Boys

By Dean Baker | bio
In a Financial Times column whose logic escapes me, former Treasury Secretary Larry Summers calls for having the huge government created housing intermediaries, Fannie Mae and Freddie Mac, step in and start buying up more mortgages and mortgage backed securities. Summers’ says “if there is ever a moment when they should expand their activities it is now, when mortgage liquidity is drying up."

Let’s check the scorecard. The value of hundreds of billions of dollars of mortgage backed securities has just fallen through the floor because investors now realize that a very high percentage of the mortgages that back these securities will go into foreclosure. Now, why do we want a government agency to buy assets that are rapidly losing their value?

At the moment, it looks to me like we are seeing high-flying speculators getting nailed for making really stupid investment decisions. Being a mushy headed liberal sort, I like to see the government reach out to help people who are trying to get an education, who have lost their job, or need health care, but making really stupid investment decisions is not on my list. Perhaps Summers could write another piece explaining why it should be.

Summers begins his column by listing prior financial crises, starting with the stock market crash in 1987, and puts the current mortgage meltdown in this context. While I would not suggest a one-size fits all approach to financial crises, the government’s role in most of the crises on this list can be seriously questioned. For example, did the response to the 1987 stock market crash lead investors to believe that the Fed would/could bail out the stock market, and thereby lay the basis for the huge bubble of the 90s? In the same vein, did the Fed’s involvement in the unwinding of the Long-Term Capital Management’s position give a green light to investors to speculate in hedge funds, knowing that the Fed would step in to prevent the worst outcomes.

Bailouts have both immediate and long-term effects. When the immediate effect is to transfer taxpayer dollars to some of the richest people in the country that is bad news. If the long-term effect is lead investors to believe that they can engage in risky investments and the government will come to their rescue if things go badly, this is even worse news. So, I’ll take a pass on Larry Summers bailout.

No comments: