Monday, January 5, 2009
Experts' Rx on How to Get Out of This Mess
Nothing focuses the mind like a crisis, and the global financial crisis and the recession that it produced have focused the minds of economists like no other event in their careers. At the American Economic Association's meeting in San Francisco over the weekend, an annual event that draws economists from around the world, there were dozens of panels devoted to examining aspects of the global downturn -- to say nothing of the hundreds of informal discussions that popped up along hotel hallways and over cocktails and coffee. The overarching question: How are we going to get out of this mess? Here are 11 prescriptions: Barry Eichengreen, University of California, Berkeley: There needs to be a two-pronged approach. First, an additional $300 billion for banks and a mechanism for removing toxic waste from their balance sheets. Second, a minimum of $800 billion for fiscal stimulus. "I would like to see mainly payroll-tax cuts and block grants for states," he says. "Infrastructure means bridges to nowhere." Kenneth Rogoff, Harvard University: At a time when people are making analogies to the Great Depression, a little inflation would be a good thing, inducing people to spend, making it easier to pay off debts and, most important, quelling worries about the possibility of deflation. Central banks should make it clear that they believe this and that they control the printing presses. "Worrying about a couple of years of elevated inflation is like worrying about the measles when you're going to get the plague," he says. View Full Image Associated Press Kenneth Rogoff says a little inflation would be a good thing. Robert Hall, Stanford University, and Susan Woodward, Sand Hill Econometrics: Infrastructure spending can cause bottlenecks -- if there are only so many people who can install broadband, much of a big broadband package will go to overpaying the installers, for example. But moves like tax rebates just increase saving. So the husband-and-wife team argues for a massive sales-tax holiday, which would induce consumers to spend more, putting the stimulus right where it is needed. To compensate states, "have the federal government buy out sales taxes," says Mr. Hall. The handful of small states with no sales tax could have the federal money go to their coffers instead. Robert Shiller, Yale University: The consensus on fixing the economy seems to be to first put in short-term policies to get things going again, and then put in longer-term stuff. But that may be getting it wrong. "We want to make changes that are long term rather than these fixes -- people perceive them as fixes," he says. One thing he'd like to see is subsidies for financial advice, so people aren't making mistakes going to a mortgage broker to find out how much house they can afford. View Full Image Reuters Robert Shiller favors longer-term measures rather than quick fixes. Alan Blinder, Princeton University: The downturn is still young, it is going to go on for much longer, and it will be very deep. "We need to think of having time-release capsules," he says, that will help boost the economy a year from now. Infrastructure spending, which some economists argue against because it takes awhile to be put in place, does exactly that. Anil Kashyap, University of Chicago Booth School of Business: Policy makers should stay focused on recapitalizing the banking system. The $350 billion of funds from the Troubled Asset Relief Program hasn't been sufficient to repair the balance sheets of financial institutions sitting on hundreds of billions, if not trillions, of dollars in losses. And financial firms won't start lending again until their balance sheets are in better shape. But bad banks should be shut down or nationalized more aggressively. "It is a complete waste of taxpayer money to bail out somebody who is insolvent," he says. Jeremy Stein, Harvard: The government needs to aggressively audit banks, separating the insolvent from the solvent. The key underlying problem is the ad hoc bailouts that have taken place so far. That leaves market participants uncertain of the government's strategy "and therefore paralyzes potential private-sector investors," he says. José Scheinkman, Princeton: After determining which banks are insolvent, the next step is figuring out what to do with them. "We have three options," he says. "You can merge them with good banks, invite foreign banks that are not so active in the U.S. to take control, or have the government nationalize them and clean them up. I suspect we will need all three." Adam Posen, Peterson Institute for International Economics: Part of the U.S. problem is that the banking system has become much bigger than it needs to be -- similar to the situation Japan faced, and was glacially slow to deal with, in the 1990s. "Fiscal stimulus will work fine in the short term, but you've got to shrink the banking sector before the fiscal stimulus runs out," he says. Douglas Diamond, Chicago Booth: There needs to be a better way to resolve problems at bank holding companies than their threatening bankruptcy and then getting bailed out. "You have lots of carrots and no sticks right now," he says. One alternative would be legislative changes that would allow regulators to quickly wipe out existing shareholders at problem banks without invoking bankruptcy, and convert long-term debt issued after the legislation went into effect to equity. That would effectively recapitalize the bank without the need for government money. And it would give big incentives to investors to buy banks' debt, and to banks to raise capital in order to keep their shareholders from being wiped out. Markus Brunnermeier, Princeton: Putting in a new regulatory framework for the financial system may seem less urgent than getting the system going again, but waiting around could mean that the political will to make important changes will no longer be there. One of the things that led to the crisis is that regulators concentrated on the riskiness of individual banks, rather than the risks posed to the system. "What they should focus on are risk spillover effects," he says. "What damage can a bank's failure cause to other banks? We need new risk measures on this."