Blinder: Bank profits 'collateral damage in a war to save the economy'

Jul 29, 2010 — Washington Post

Ezra Klein

Alan Blinder is co-director of Princeton's Center for Economic Policy Studies and formerly served as vice chairman of the Federal Reserve's Board of Governors. We spoke on Wednesday about the paper (pdf) he co-authored with Mark Zandi attempting to comprehensively estimate the economic effects of the financial interventions and stimulus (my interview with Zandi is here). A lightly edited transcript of our conversation follows.

Ezra Klein: What your paper says, essentially, is that the financial rescue and the stimulus have been very successful. But both are unpopular. In the case of TARP, we’re talking horribly unpopular. But that’s one of a basket of policies you credit with literally millions of jobs. How do you explain it?

Alan Blinder: In the case of the TARP, which people identify with the bank bailouts, they feel it was successful in ways they’re not happy with. That is, the bankers are making a lot of money now. That part of the bailout cost the government less than nothing, as the government is turning a profit on it. But in some moral sense, these bankers did not deserve to be saved. The problem was that if they went down with the ship, we were going down too. The right way to think about the banker benefits was collateral damage in a war to save the economy. Had we not done that things would’ve been horribly worse for everybody. So I don’t hesitate. To me it’s not close.

The analogy I’ve heard is that it’s like the old ethics question: Do you push a child in front of a bus if it’s the only way to save the passengers?

I think that’s right. There are lots of picayune details that I would, and did, criticize about the way Paulson did TARP, not the least of which was the unconstitutional first draft. But that some such thing was necessary was beyond dispute. It did a lot of good.

Expand on that. How would you have done it differently?

I think there are a number of ways. TARP should’ve come with more strings attached. A lending requirement, for instance. If banks were going to get this money, they should’ve had to lend with it. I would’ve put restrictions on banks ability to pay dividends, and tougher restrictions on executive pay. I also think it was a very big mistake for Secretary Paulson to force this money on banks that didn’t want it. I can hardly say his theory without laughing: He wanted to reduce the stigma of taking it. The market knew who was strong, and the strong banks, like JP Morgan, went to the media and loudly said that the government is forcing this down our throats.

On the stimulus, this’ll sound funny: It was a mistake to have it begin with a seven. I’ve heard this from several congressmen: They say their constituents are confused between the $700 billion TARP, which they hate, and the $787 billion stimulus act. It could’ve been $812 billion. Second, the price of getting three Republicans in the Senate was letting them stuff in things that shouldn’t have been there. My least favorite was the carryback of net loss assets. Mark [Zandi] charitably gives the loss-carryback 22 cents on the buck [of stimulus]. At the other end, food stamps are $1.74 on the buck. And there were other things like that that could’ve been taken out of the package or replaced with things that had more bang for the buck. It definitely could’ve been better designed.

In the past few months, the recovery seems to have hit a wall. So on some level, the policies aren’t working, or have stopped working. What’s your explanation?

Well, I know why it is, though it pushes the question back one level: Given the growth of GDP and the amount of spending that’s come online, the number of jobs created has been puny. That’s mitigating the usual virtuous circle where spending creates jobs and those people spend and that creates jobs and so on. That process is going on, but not at the level we expected. That pushes the question back to how come there’s not more hiring. My speculation is that it’s doubts about the durability of the recovery and firms not wanting to hire more permanent workers until they’re more confident this is for real.

When I spoke with Zandi, he named policy uncertainty as a key contributor to that fear. Do you agree?

It’s hard to say. There’s something to it. People don’t know what’ll happen with the tax code, though my guess is the answer is not very much. They’ve got a new health-care reform to digest, though it’s not that major a change for you if you’re not in the health industry. And now there’s a new financial reform to digest, but if you’re not in one of the financial industries, it’s not terribly relevant. These changes might impact you, but they’re not first-order compared to how much you can sell.

Another theory I’ve heard is that there’s a generalized fear of tail risk now. If there’d been no financial crisis, we’d still have question about the tax code and energy policy and health-care policy. We’d still have a long-term budget deficit. But having watched the economy crash unexpectedly in 2007, and then seeing the European debt crisis hit, and then seeing the recovery stall, people are just scared. As opposed to being worried about one risk, they’re worried about all risks, even and especially those that they can’t quite predict. So until the economy really seems robust again, they’re holding back.

This is possible and unfortunately I’ll have to confess that there is nothing in the economist’s toolkit that enables us to test that question. A paraphrase of your question is, might it be that unprecedentedly bad events have created uncertainty? Because they’re unprecedented, we can’t estimate them.

So what would you do going forward?

I would do two things, both aimed at jobs: I would do the so-called new jobs tax credit on a much bigger and better scale than the HIRE Act, which was a baby step. The second thing I would do is a WPA-like program of temporary, direct, public hiring. People could work in parks, in maintenance, the many paper-shuffling jobs there are in government. You could save a lot of state and local jobs that would otherwise be terminated.

Before I forget, your paper is based off of Moody’s Analytics model. There’s some argument as to whether you can trust these models, or whether they’re really just a reflection of the biases of the authors. Why should we believe your results?

First of all, you shouldn’t trust it completely, and that’s why we say we welcome others to try and estimate this, too. Different models do give different answers. In the past, I’ve used two or three models and tried to get a sense of where they agree and disagree. So I agree you can never rely on one model totally. But you can’t make anything come out that you want. These models are fitted to real data. They’re not just made up. They describe how the U.S. economy worked in the past. And when you shove something new through them, it’s really hard to guess the answers. I didn’t have any idea for many of these unusual financial policies that we modeled, what would come out. And we didn’t do it over and over to get the answers we wanted. It was an honest simulation of the model.

Where did the results surprise you?

I was surprised. Not by the fiscal side. Other people had done those calculations and come to similar answers. Mark Zandi had been one of them. But I was surprised, and I think Mark was too, by the very large effects we got from the compression of interest rate spreads, which is how we modeled the effects of the financial policies.