Criticism of the U.S. Bailout Plan, Part 4

Economics Unplugged: A conversation with Professors Allan Meltzer and Marvin Goodfriend is a just released 60 minute interview which took place on April 22, 2008. Meltzer and Goodfreind, two professors of Economics at Carnegie Mellon, discuss the current financial crisis and how we got here.

As free market economists, they continue to be very skeptical that increased federal regulation and oversight will be enough to avert future problems. In their opinion, increased regulation will not work, because although lawyers write regulations and accountants enforce them, the management of banks and investment banks will always find a way to circumvent them (regulations).

Bank management has an incentive to take big risks to earn large rewards, and the rewards are incorrectly based on short term results. Meltzer thinks bank executives should be paid “on the average of their performance over five years, not quarter by quarter. There are other ways of doing that, but we have to change their incentives, otherwise we are going to have these problems.”

If you believe that better regulation is the solution to the financial crisis, you might find a different viewpoint interesting.

Their key points are:

• The main problem is that financial institutions lend on a long term basis, but borrow on a short term one. Periodically, there is going to be a problem.
• Regulation has a limited role to play in disciplining markets.
• Think about incentives when writing regulations.

Other observations are:

• The current situation is very different from the Great Depression.
• Banks have to recognize their losses and raise more capital.
• We will not know how bad the economy will get, until we see how far housing prices will fall.
• We are seeing the end of the American Century, where the United States had a dominant influence on what happened in the rest of the world.

Although this interview is almost 6 months old, Professor Meltzer recently expressed similar conclusions. On September 23rd on a PBS News Hour program, he was asked whether he thought the bailout plan was a good idea. His response, “It’s a terrible idea. It’s undemocratic. It’s bad economic policy, and it’s bad social policy. And it has a very little chance of solving the problem in a meaningful way.”

photo credit: Matti Mattila