The Yale Book of Quotations provides a useful service: It tabulates well-known sound-bites, but tries to get the exact quote and citation right, which is rare.    (P.T. Barnum in fact never said “There is a sucker born every minute.”    Richard Nixon never said “But it would be wrong.” Etc.)  The editor also compiles an annual list of Top Ten Quotes of the Year.   In the second week of December he released the list for 2008.  Number 1, for example, is “I can see Russia from my house” (carefully attributed to the Tina Fey parody rather than precisely what Sarah Palin originally said).

The good news is that the title line in my blogpost of July 17 was chosen as one of the top ten quotes of 2008 (tied for tenth place, it is true).    The sentence is: “If there are no atheists in foxholes, there are no libertarians in financial crises.”     The bad news is that the quote was attributed to Paul Krugman, who had used it subsequently on the Bill Maher Show.   I had originally written it in 2007 as the first line of an article in a Cato Journal issue devoted to financial crises.  Among the others who picked up on the line after my blogpost were Ben Bernanke,  Mark Shields, Bloomberg,  WSJ.com, Brad deLong, and Tom Keene – generally with attribution, when the format permitted.

The list of Top Ten Quotations of 2008 went out over AP on December 15 as it was, and appeared in lots of newspaper stories and TV broadcasts.  Krugman immediately set the record straight on his blog, as I knew he would.   AP sent out a correction on December 22.    It should be obvious that this is not a scandal of any sort and that Krugman is just as quotable as he ever was.
  

But there are some other, more interesting, aspects.

One is an illustration of how tough is the world in which highly visible columnists like Krugman live.   There are lots of Krugman-haters out there.  Of course the phenomenon originates in the fact that he consistently has been liberal and anti-Bush (not precisely the same thing).  But the antipathy goes very deep.    The Yale/AP list was originally called to my attention by one Joel West.   I told him I was indebted to him for pointing out the misattribution.   But I also told him that I was sure that there had been no desire on Paul’s part to steal my line:  TV shows like Bill Maher don’t customarily allow their guests to display footnotes.     But Mr.West must be one of the Krugman-haters, because his subsequent blogpost accused Krugman of dishonesty.   As had another Krugman-hating blogpost before that.   These people are eager for ammunition against someone of a different ideological persuasion and are not sufficiently discriminating about what they use.

Ironically, of the other two soundbites that share tenth place on the Yale/AP list with the atheists-libertarians quote, one is something else attributed to Krugman (“Cash for trash”), and the third is from the all-time champion Krugman-hater, Donald Luskin.   Luskin earned the Top Ten honor when quoted as saying “Anyone who says we’re in a recession, or heading into one — especially the worst one since the Great Depression — is making up his own private definition of “`recession’”  in the Washington Post, September 14.    This was of course after a huge fraction of economic commentators and the public had already decided that the country was probably in recession, as now turns out indeed to have been the case.   (I myself took a bit of grief on various blogs both for saying the “R word” too early and also for saying it too late.  But I have also gotten credit.)

The atheists-and-libertarians line itself has also drawn some grief from some atheists and libertarians, on various blogsites.   I don’t mean to put these two philosophies together (although that would be an interesting essay question on some exam).  Nor is it the case that either group is objecting to being associated with the other.   But both have pointed out that the statement is not literally true.   They are entirely correct:  There are plenty of atheists in the military;  and there are plenty of libertarians in a financial crisis.  But of course the statement did not literally mean there are no atheists in foxholes or libertarians in financial crises.  The claims are, rather, that on average:  (i) soldiers under fire tend suddenly to grow more religious in outlook, and (ii) policy-makers facing a financial crisis tend suddenly to grow more interventionist in outlook.    But, yes, there really are conscientious atheists in foxholes.   They are a minority, but a substantial one.   And yes there really are thoughtful libertarians in financial crises.  Again a minority, but not to be dismissed.   If anything, I admire the intellectual consistency of those who have thought through their views well enough ahead of time that they do not change them under pressure from events that, even if calamitous, were predictable. 

 
Every two years, Harvard Kennedy School hosts the newly elected Members of Congress for a three-day “briefing” on a wide variety of topics.   We had an excellent turnout this week: 40 of the 50 new congresspeople, from both parties.    I participated in a panel titled “Understanding the Economic Crisis,”  along with Greg Mankiw, Elizabeth Warren and Robert Lawrence  (on video).    

Trying to explain the origins of the financial crisis and recession in ten minutes, even to the extent any of us understands it, was a tall order.    But I tried to cram it all into a single slide.     Here it is: 

News services reported today that Tim Geithner, currently President of the Federal Reserve Bank of New York, was President-elect Obama’s choice to be Secretary of the Treasury. The fiancial markets reacted very positively to the news. This presumably captures both relief that some policy uncertainty has been resolved at this critical juncture and approval that Geithner is the man chosen.   I share the pleasure at this appointment.

Tim Geithner is refreshingly straightforward and personable, and doesn’t “stand on ceremony.”  At the same time, he is cool and unflappable. By coincidence, the Economic Advisory Panel to the NY Fed President, of which I am a member, met today. Unusually, Geithner excused himself at two points in the four-hour meeting to take short phone calls. Given the timing, it seems very likely that one of the phone calls was Senator Obama offering him the Treasury position. These Panel meetings are off the record, but I think I am not betraying any confidences to report that Geithner betrayed no sign to us of what had just happened. No change in demeanor, no change in the substantive flow of the discussion. This is a guy who does not lose his cool.  Just what the country needs.

Most sensationally, Summers is said to be tainted by his time as President of Harvard.    Too much has already been said about this.   But I will make just a couple of observations.    First, although Summers may not be Mr. Personality, and he will never be elected to high office nor chosen to head offices for women’s rights or the environment, he has all the most important qualities for the Treasury job.   Despite a tendency to say what he thinks, I don’t think he committed any true faux pas or became involved in any mini-scandals during 8 years in the government — no easy feat.   (The closest he came to a faux pas, or what counts for one in the media, was a statement that the argument that was then being made for abolition of the estate tax was based on greed alone rather than efficiency.   He quickly retracted the statement without bothering to try to explain what he had meant, having already by then become familiar with the rules of political brouhahas.)    In his time in Washington, he learned how to get along with politicians across the spectrum, from socialists to the far right.   It’s true that he wasn’t able subsequently to get along with the full range of faculty in the Harvard English Department, but that is a tougher task.  

Finally, I continue to be surprised at how the press describes Summers’ ill-fated and ill-considered (but “off the record”) remarks regarding explanations for the lack of women in academic science departments.  He is most often reported as having suggested that women generally have less aptitude for science than men.   Memories of these remarks in some quarters probably accounts for the recent decline of Summers in the betting odds, though he also has defenders among women with whom he has worked.   I link to the text of what he actually said here,  and urge readers to make up their minds for themselves.   But I don’t read his speculative remarks about the various hypotheses quite the way most people have assumed.   To me the most outrageous line in the remarks was, rather, the suggestion (made to illustrate the penalities for being out of the academic workforce for a couple of years) “that no economist who had gone to work at the President’s Council of Economic Advisers for two years had done highly important academic work after they returned” !  

The members of the G-20 are meeting in Washington on November 15 to discuss reform of the global financial system.  The first thing to say about the calls for a “new Bretton Woods” is that they overreach, in the sense that it is very unlikely that any changes in the structure of the international monetary or financial system will or should, at this point in history, come out of multilateral discussions that are big enough to merit comparison with the first Bretton Woods. Certainly we are not talking about fixing exchange rates, as the 1944 meeting did.

Detour for an anecdote.  In mid-1998, when the crisis that originated in Southeast Asia had reached its one-year anniversary without abating, President Bill Clinton decided to give two important speeches.   He wanted to call for a new Bretton Woods.   His economic advisers (including both at Treasury and in the White House) advised him against this, on the grounds that one should not call for something as portentous as a new Bretton Woods when one was not likely to have proposals substantive enough to merit the name.   Soon after the (successful) speeches, British PM Tony Blair called for a new Bretton Woods.    Clinton asked his advisers, “How come Blair got to call for a new Bretton Woods when you wouldn’t let me do it?”    Our answer was along the lines, “Blair’s Treasury Secretary, Gordon Brown, doe s not necessarily have his interests aligned with his boss, in the way that Bob Rubin does.   So Brown had less incentive to stop Blair from saying something foolish.”   The big irony of the story is that Brown today is himself leading the move for a “new Bretton Woods.”

Even though the effort is virtually certain to fall short of a true “Bretton Woods 2,” it is worth taking the opportunity to consider what changes – whether more ambitious or less — might be made at the multilateral level to improve the functioning of the system.

Changes in government policy at the national level have already been radical in many countries, compared to anything that would have been imagined a short time ago:
• central banks’ extension of credit to institutions and under terms not contemplated in the past,
• governments’ buying up bad assets and recapitalizing, taking over,, or otherwise transforming troubled banks and financial institutions),
• agencies guaranteeing deposits (without limit) and money market funds, and so on.

Some of these steps can be done at the purely domestic level (US takeover of Fannie Mae and Freddie Mac); others require cooperation between a small number of countries (rescue of Fortis by Benelux countries); but others arguably require multilateral agreement, and thus are candidates for a modest “Bretton Woods.”

•  The International Monetary Fund has been given the task of outlining what a new Bretton Woods would look like – appropriate since the IMF is one of the original Bretton Woods institutions (along with the World Bank).
      o An Early Warning system is almost certain to be high on its list. But it already developed early warning indicators, after the East Asia crisis of 1997-98, and they haven’t been much help.
      o Now that the financial crisis is spreading to small economies like Iceland, transition economies in easternmost Europe, and poor countries like Pakistan, the IMF country rescue programs will get back in the saddle.
           This time around, however, the Fund has more competition (including from the ECB, the Gulf countries, China, and Sovereign Wealth Funds), and partly for that reason will probably demand less conditionality from the borrowing countries.    Also the Fund will have to turn to newly-wealthy countries like China to help finance  new facilities and programs.
              • Bill Rhodes has proposed that the Fund facilitate expansion of currency swap arrangements, to allow emerging markets to have the same access that has been made available to developing countries.
              • Michael Bordo and Harold James have suggested that the Fund could manage reserve assets of the new surplus countries; but it is not clear why the latter should want it to.
          The Contingent Credit Lines (CCL) – which were launched by the IMF with some fanfare in the aftermath of the 1997-98 East Asian crisis but were never attractive enough to attract a single client country — are back now, in the form of  new Short-Term Lending Facility.  The idea has always been that countries that have followed blameless policy (or as far as we can come to that in the real world), as judged by pre-crisis criteria, should be able to borrow large amounts from the Fund very quickly when faced with global contagion, without the usual conditionality.    Brazil and Korea look like two countries that had done most things right in recent years (flexible exchange rates, high level of reserves…) and have nevertheless since September seen international investors disappear.    The IMF has responded appropriately, with CCL-type loans that are multiples of country quotas.  
          Only a small number of countries qualify for having followed “blameless policy.”  Morris Goldstein suggests that the larger class of countries that have now been hit by forces beyond their control — the US-originating financial crisis — be helped by a revival of a long-ago IMF loan window, the Compensatory Financing Facility.
• The problem is that the money that the IMF is now able to offer is not only small relative to global capital markets (the IMF has long been used to that circumstance), but also small relative to the countries’ own reserves or to the no-condition funds that the Federal Reserve has now offered them through swap lines.   To expand such facilities, the IMF needs more funding.  Where will it come from?  Sovereign Wealth Funds and central banks in East Asia and Gulf countries.   But that in turn requires giving these countries much greater political representation than they currently have in the Fund.
              o There has been a loose one-year campaign to suggest guidelines for the operations of Sovereign Wealth Funds themselves, to “regulate” them.  But benefits of the SWFs may be more widely appreciated now than a year ago, in the context of the current crisis.   
              o The IMF, just as all the multilateral economic institutions, has moved far too slowly to give added representation to the newly important developing countries such as China, Brazil, Korea, India and Mexico – representation at least in proportion to their economic role, to say nothing of population.
                  A big part of the problem is that larger quotas and voting shares for these countries would have to come to a substantial extent out of Europe’s share.
                  In a fair world, Europe would also give up its stranglehold on the Managing Directorship (especially after the performance of the recent incumbents, who have appeared less interested in their jobs than in domestic politics back in their home countries or in putting new meaning into the phrase “foreign affairs”).  The same goes for the U.S with respect to the World Bank presidency.

•  The G-8 has been increasingly handicapped in recent years by virtue of its obsolete membership.
      o The G-7 still retains some relevance, in its role as self-appointed steering committee for world governance. After all, this financial crisis did not start in the developing countries, as it did those of 1982, 1997 and 2001.
     o But the G-7 cannot discuss the spread of the crisis to developing countries without Korea, Brazil, Turkey, India and Mexico at the table.  It cannot discuss central topics such as global current account imbalances, or the need for exchange rate adjustments, or coordinated global fiscal expansion, or requests that surplus countries fund rescue programs,  without China and Saudi Arabia at the table.     Thus it is appropriate that the G-20 is the group that has been invited to to the November 15 summit in Washington to discuss the new Bretton Woods.   
     o  Coordinated fiscal expansion is the most likely substantive macroeconomic policy outcome of the G-20 meeting.
      
• A probable substantive structural outcome from talk of the need for a bold new multilateral initiative is that there could be a “Basel III” to replace the “Basel II” agreement.
      o It would make capital requirements on banks countercyclical, rather than what has turned out to be procyclical, i.e., destabilizing, under Basel II. (Ironically economists at the BIS in Basel probably deserve credit for being the observers, in addition to Charles Goodhart, who most accurately warned of the procyclicality before the crisis.)
      o A Basel III could also replace the option of self-regulation of banks (under which they could choose their own Value At Risk models) with external regulation.    Dan Tarullo, who could have a  major role on the Obama team, offers some ideas .
      o The highly capable chairman of the Financial Stabilty Forum, Mario Draghi, assures us that already this year substantial progress has been made in such important areas as reducing conflict of interest on the part of credit-rating agencies.
      o International guidelines for guaranteeing deposits (possibly reinstating a ceiling, such as $100,000, after the crisis has passed) should perhaps be coordinated, to avoid flight of the sort that Ireland’s European partners experienced.

• Other possibilities:
      o A more ambitious reform would be to try to agree on guidelines to extend prudential regulation from international banks to non-bank financial institutions, since the latter were such a serious part of the problem in 2008 that many either failed or were bailed out, against all expectations.
      o More radically, regulation of this sort not just agreed multilaterally but carried out multilaterally, rather than at the national level, by the BIS (which now includes major emerging market countries) or a new agency.
      o The IMF, Financial Stability Forum, and other institutions will vie to lead the effort.
      o Other proposals, many of which could be attempted at the national level, but would optimally be coordinated internationally:
           A securities transactions tax, harmonized internationally, to raise revenue in a way that satisfies the public’s understandable feeling that the financial sector, which created this financial crisis, should not benefit from the solution.
           Executive compensation reform (especially in the financial sector).   Options-based bonuses have not been implemented in the incentive-compatible way that the corporate finance theorists anticipate  d, and have instead encouraged inordinate risk-taking.  One possible solution is to discourage compensation by options, in favor of restricted stock.    Another is to regulate corporate governance so as to insure that the CEO’s buddies don’t comprise the committee that determines his or her compensation.
         Regulation of the “originate to distribute” model of mortgage lending. Mortgage-Backed Securities were a useful innovation, but were carried too far.  The banks or mortgage brokers that originate a mortgage loan should be required to reattain a certain slice of each one (some have suggested 1/5), before selling the rest on, so that they have an incentive to monitor the creditworthiness of the borrower.  
           Regulation of Collateralized Debt Obligations.   Perhaps it is enough to raise capital requirement on the holders.  Perhaps something more drastic is required. 
           Regulation of certain derivatives, particularly Credit Default Swaps.  Perhaps it would be enough to standardize CDSs and set up a central clearing house, as many observers have suggested.
           But there is a danger that derivatives regulation could do more harm than good, e.g., a ban on futures markets or short-selling.
  o At the other end of the spectrum, one should consider the possibility that doing nothing might in the end be better than undertaking fundamental reforms in the international financial system, if the latter were driven by clumsy politics.

[To anyone wishing to post a comment:  I recommend you go to the RGE version of this post.]

I propose that the Congressional leadership re-introduce the Trouble Asset Relief Program accompanied by a major new policy: a small tax on securities market transactions. This will accomplish the political goal of aiming a silver bullet into the heart of the (understandable) popular outrage that blocked passage of the TARP bill on Monday. It will simultaneously accomplish the fiscal goal of raising revenue in the future. This is revenue that the federal government would have sorely needed even before the bailout arose and will need even more if the taxpayer is to be protected against the risk of heavily subsidizing the financial sector.

A tax on securities market transactions might sound like a wild populist policy that would damage the functioning of the economy. But in fact it is probably more sensible than such populist measures as banning short sales, which has already been tried (to no avail).

Proposals for financial transactions taxes have a distinguished pedigree, going back at least as far as Keynes.  Best-known is the Tobin tax proposal, by Nobel Prize winner James Tobin, which was specifically aimed at volatility in foreign exchange markets. More relevant to what I am proposing are two articles by the pre-Treasury Larry Summers: “A Few Good Taxes” and “When Financial Markets Work Too Well: A Cautious Case for a Securities Transactions Tax” (1989).   Add to the list of proponents another Nobel Prize Winner, Joe Stiglitz.

There is extensive experience with securities transaction taxes (STTs), especially in other countries.  There have also been quite a few studies of their effects. Often the motivation for such proposals is to reduce short-term speculative turnover:   a tax of 0.1% means nothing to a long-term investor, but is a strong disincentive to those traders who hold their positions for only minutes or hours.  The idea is that reducing short-term speculation will reduce volatility.  On the other hand, defenders of unfettered financial markets often argue that such a tax will reduce liquidity and thus hurt the customers who depend on the market.

The general historical experience seems to be that there is no discernible effect on volatility (though a couple of studies find effects on volatility, either upward  or downward).   In other words, the tax might not help the functioning of the financial markets — the original motivation – but neither does it hurt, according to a majority of the studies.  In some cases the volume of trading within the country is affected.  But what the tax does does usually do is raise money for the Treasury.  

The UK long had a securities transactions tax, known as a stamp duty, which was set at 0.5% in 1986.  Sweden introduced a 0.5 per cent tax on the purchase and sale of equities in 1984 — prompting some financial trading to move offshore – and kept it until 1991.  (Froot and Campbell, studied these two examples in a 1994 book that I edited.   The Swedish case is particularly relevant to the current US context because the popular motivation there was to “take down a peg” high-earning speculators.)    Japan, Korea, Taiwan and Hong Kong have a long history with securities transactions taxes, and India introduced one in 2004; in these cases there were not significant reductions in either price volatility or market turnover.  Other countries that have had financial turnover taxes of at least 0.1% include Australia, Austria, Denmark, Finland, France, Germany, Malaysia, and Singapore.  (Germany abolished its turnover tax in 1991, and Japan in 1999.)   In addition there are other countries that impose smaller fees.

Even the United States had a STT until 1965, and to this day imposes an SEC fee of .0033%.  Thus we have already lost our virginity !

An important potential drawback, if the US were to impose a more substantial transactions tax alone, is that it might drive financial business offshore.   There is an answer to this point.  As noted, many countries already have taxes on financial transactions. Furthermore, lots would love to cooperate with the United States in an international program to harmonize such taxes internationally. This is precisely the sort of project in which many abroad have long asked Americans to participate, but which we have not hitherto wanted to do.

The level and longevity of the tax might be adjusted to achieve the goal of Section 134 of the TARP bill: that the taxpayer recoup the costs of the bailout. A 2004 study by the Congressional Research Service reported that an 0.5% tax on stock transfers could raise $65 billion a year.  Others have produced higher revenue estimates.   A tax extended to bonds and derivatives (especially derivatives!) would of course raise more.   Remember that one does not compare this annual revenue to the $700 billion headline cost of the bailout.  Rather, one compares the present discounted value of the annual flow of revenue to however much of TARP’s $700 billion is left over after the government (we hope) collects something on the troubled loans and also recoups something on warrants obtained from the participating banks.

The tax might on the margin contribute to a shrinking of the size of the financial sector; but this shrinking needs to happen anyway, as Ken Rogoff has pointed out. And most important politically, it would give expression in a non-damaging way to the blood lust that the public feels toward Wall Street, a venting that needs to take place if the bailout bill is going to be approved.

[To any readers who wish to post comments:  I suggest you go to the RGE version of this post.]

When the Treasury came out with its $750 bailout plan on September 22, I  thought it lacked so many necessary ingredients that it deserved a thumbs down.  (Many others had similar objections, including George Soros.)

But in the negotiations between the Treasury and Congressional leaders over the course of last week, most of the missing ingredients were inserted.    Starting with the additions that were most necessary on the merits, and moving toward the ones where the necessity was more political, they were:

·        Institutionalized oversight of the Treasury, which had previously been startlingly absent.

·        Provisions so that the taxpayer would share in the upside potential of banks and other financial institutions, rather than just socializing the losses.  These provisions should allow the possibility that the government could recoup most or all of its short-term losses as has often ultimately been true in past unpopular bailouts.

o       First, by giving the government equity stakes in the banks that sell their bad loans to the Treasury.

o       Second, by having the president in five years submit legislation to recoup the cost from the financial sector if the taxpayer is still in the red at that point.

·        Limits on executive compensation, especially golden parachutes, at banks taking advantage of the opportunity to dump their bad loans on the Treasury.

·        Dividing the $750 billion into three slices over time, which at least offers the congressional negotiators a little bit of cover.

·        A provision for possible government insurance of mortgages instead of acquisition of them.   This was a bone thrown to the Congressional Republicans who had blocked the plan several days ago; I don’t know why they would want this provision, but at least it can’t do much harm.

Some other proposed provisions, from both the right and left, were left out, and for good reason in most cases.

The plan (TARP for Troubled Asset Recovery Plan) would still be unprecedented in magnitude and in the discretion it gives the Treasury Secretary.   Even if the Congress had passed it today, it would not have guaranteed an end to the financial crisis, let alone averting the recession that is probably already inevitable at this point.   Furthermore it does little to begin the reforms in regulation that our financial system now clearly needs.

Nevertheless, and as distasteful as it is to be “bailing out” Wall Street, or even bailing out those homeowners who took out loans that they shouldn’t have, let alone bailing out policymakers who were asleep at the switch, my view is that the program is necessary.   It is better than the alternatives:   

• better than the Treasury proposal of 9/22,
• much better than the proposal we would have gotten from a pre-Paulson Bush Administration,
• better than the alternative that the House Republicans are offering, and (most important of all) 
• better than the alternative of doing nothing, which would (will?) quite likely mean a severe recession.

I suppose it is not surprising that Congressmen facing elections in 5 weeks don’t want to go on record supporting something so unpopular.   What will happen now that the House rejected the deal in its vote today?   Most likely the stock market and real economy will plummet, until the pain gets so bad that a bailout package like this one accumulates more support.

I expressed my views this morning on the NPR radio show On Point.

[To any readers who wish to post comments: I suggest you go to the RGE version of this post.]

In time of war, there is a tendency for both political parties to rally around the president, as we saw (all too well) in Iraq after September 11. In time of financial panic, there is often a similar inclination. The two presidential candidates, for example, are being careful in their statements. I don’t blame them. The issues are too complex to be taken on inside the context of a political campaign. Both candidates realize that the danger of a verbal misstep that the other side can try to blame for worsening the crisis is far greater than the likelihood that either one will come up with a brilliant solution that will gain widespread support or will solve the problem, let alone both.

Quite a few economists are worried about moral hazard in financial markets.   Vince Reinhart wrote a Wall Street Journal column rebuking his former bosses after the Bear Stearns intervention: “…the Federal Reserve’s action can only be viewed as rewarding bad behavior.”  Ken Rogoff recently wrote in a Financial Times column, “it is important to be tougher in busts, so that investors and company executives have cause to pay serious attention to risks. If poorly run financial institutions are not allowed to close their doors during recessions, when exactly are they going to be allowed to fail?”   

Of course moral hazard is a serious problem that lies close to the heart of the financial market crises.   But I am not sure that I completely share the priority at this point on drawing a tougher line with the ex post bailouts. It may be futile advice.   Fixing the hole in the roof when it is raining is, after all, rather difficult.

Consider two other areas where moral hazard is an issue: commercial banks and river banks. Some economists would prefer that the government refrain from helping the victims of banking panics and river floods, respectively. The worry is that if those who overlend or overbuild do not bear the full costs of their mistakes, they will have no incentive to be more careful in the future.

But I think we figured out some time ago that in practice no democratic government will ever ex post turn its back on poor shivering families who appear on TV huddled in front of the ruins of their flooded out homes (or banks). It is wiser that we recognize this fact, and design a regulatory system that explicitly incorporates mandatory federal flood insurance and deposit insurance, and charges for them up front. We already do this for commercial banks. To me, the lesson of recent months is that we need to do it for investment banks and a wider range of financial institutions.

As a final tweak, I can’t help noting that central bank governors, Treasury secretaries, and chief executives who make the most noise about the evils of moral hazard and bailouts ex ante, are no more likely to stand firm ex post than others. If anything, the reverse.  I am thinking, for example, of how - ten years ago this month - it was the Clinton Administration that finally pulled the plug on continued IMF loans to Russia, despite well-founded fears of systemic contagion.   The Reagan Administration in the 1982-84 international debt crisis and the Bush Administration in the 2001-03 Argentine crisis, for all their laissez-faire rhetoric, never pulled the plug on any of the debtor countries.    When sitting in the hotseat of a financial crisis, officials suddenly discover a need for bailouts, much like soldiers sitting under fire in foxholes sometimes suddenly discover a need for religion.

[Any readers wishing to comment on this blog post:  I suggest you go to the RGE version.] 

Someone this week asked me what I thought of policy-makers who ex ante profess a free-market ideology and acute sensitivity to the dangers of moral hazard from financial bailouts, but who toss that ideology overboard when faced with a financial crisis.  The reference was to Treasury Secretary Henry Paulson’s lobbying this week in support of a rescue for Fannie Mae and Freddie Mac, the two big home mortgage agencies, following on the rescue of Bear Stearns in March.   My reply was:  “They say there are no atheists in foxholes.   Perhaps, then, there are also no libertarians in financial crises.”

There are more egregious cases than Hank Paulson of inconsistencies between ex ante promises by policy-makers not to bail out and ex post bailouts when disaster strikes.    (Indeed, some amount of change in position may even be rational for an office-holder, though I would draw the line at false statements.)    I reserve my disdain for those who go around lecturing others on the evils of bailouts, only to out-do the officials they criticized when their own turn in the hot-seat comes.  

An example I have in mind concerns the members of the starting team in the Bush Administration who had lectured the Clinton Administration on the evils of its allegedly excessive bailouts of emerging markets in the 1990s, only to engage in worse when they themselves were faced with the Argentine crisis that began in 2001.  There was no particular reason to rescue the Kirchner government.   Argentina in 2003 would have been the perfect place to refrain from rolling over an IMF program, thereby putting a limit on the moral hazard problem.   The Clinton Treasury had done this with Russia in August 1998 despite high costs in terms of systemic contagion.   Yet the Bush White House continued to push the IMF to bail out Argentina.  Apparently the failing lay in simple inexperience and lack of awareness that any such choices are always difficult.   (See pages 9-11 of my article on Managing Financial Crises, in the Cato Journal, Summer 2007.)    The Administration was very much following in the footsteps of the Reagan Administration, which talked tough at first when the international debt crisis hit in 1982 but which then participated in comprehensive IMF-led bailouts of Latin American debtors who had been pursuing far worse macroeconomic policies than the emerging market governments of the 1990s crises.  

Incidentally, before writing this blog post, I checked into the World War II origins of the sentence “There are no atheists in foxholes.”     I discovered to my surprise that this expression was intended, and is still considered, as a put-down of atheists, and that their lobby protests its use.  

Of course the proposition is not literally true; indeed some soldiers lose their pre-existing belief in God when confronted with the horror of war.   But let us stipulate that those who suddenly face death more often find religion than lose it.  What strikes me as odd is that the expression is apparently normally interpreted as meaning that people who profess atheism don’t really mean it, and that their true colors come out under pressure.     I had, apparently erroneously, thought rather the reverse.   (Indeed, Richard Dawkins argues that vast numbers of people who would no more bet on the existence of God than on the existence of the Easter Bunny, nonetheless call themselves “agnostics” rather than atheists, to avoid rocking the boat.)   

I had always taken the expression to mean that mankind’s hunger for religious beliefs comes from a desperate desire for divine intervention – or, failing that, comfort – when confronting death.  Something more along the lines “There are no unsoiled underpants in foxholes.”     I am in sympathy with the character in a novel who said “That maxim, ‘There are no atheists in foxholes,’ it’s not an argument against atheism — it’s an argument against foxholes.” 

So what’s my point?    Not to argue that governments should intervene always  (nor that they should intervene never).  The lesson for government officials is that wherever they choose to draw the bailout line – one hopes the line strikes an intelligent balance between the short-run advantages of ameliorating a serious financial crisis and the longer-run disadvantages of moral hazard — they should think through the system ahead of time.  They should take the appropriate regulatory precautions during the boom times, which correspond to the bailouts that will inevitably come during the busts.   

Long ago, the United States worked out the approximate right answer for banks:  there will always be rescue of small depositors ex post when banks run into serious trouble, and so under our system, (i) deposit insurance provides formal guarantees ex ante and (ii) banks must pay the price ex ante through reserve requirements, capital requirements, and active regulatory oversight.  What we now need to do is design the analogous sort of system for non-banks.

It should not come as a surprise to high officials that there are such things as financial crises anymore than it should come as a surprise to soldiers that there are such things as bombs.   Human nature must be accepted for what it is.   But in the case of  high officials, it shouldn’t be necessary for them to alter their fundamental beliefs when crisis strikes, in the absence of truly unforeseeable developments.