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Student Blogger - Bailout Panel: Picker, Cochrane, Baird, and Henderson

The current financial period is--according to Professor Randy Picker--an "interesting time." On Wednesday, October 15, the Law School Republicans and Democrats co-hosted a panel on the bailout featuring Professors Doug Baird, Todd Henderson, and Picker from the Law School and Professor John Cochrane from the Graduate School of Business across the Midway. The panel demonstrated just how interesting these times are with a lively discussion.

What academics try to do is understand, and Picker laid out a plan for doing so with respect to the bailout. He will teach a seminar winter quarter on bailouts with the help of Baird and Henderson, and the Law School will host a conference in the spring on the current crisis and response. The desire for an immediate response prompted this panel. If the seminar and conference are the final 451-page bailout package, this panel is like Paulson's 3-page proposal--only more successful.

Picker started with an overview of the legislation of the past 72 hours, presented through the medium of--surprise!--PowerPoint. First, the government executed the first level of the $700 billion Trouble Assets Relief Program (TARP) by buying $250 billion of preferred stock in banks. Originally, the government planned to buy distressed assets from banks rather than take a share but instead decided to follow Europe's lead. (Warren Buffett received much better terms from Goldman Sachs for his $5 billion. Picker noted, "Buffett is smarter than the government, but we knew that.") TARP has "shockingly broad" language covering "any other financial asset." Baird interjected that even language that broad may be insufficient because some instruments may not take the form of an IOU. Second, the FDIC took advantage of previously granted emergency powers to guarantee several new types of debts besides depository accounts. Third, the Federal Reserve commenced a new commercial paper program using its emergency powers under § 13.3 of the Federal Reserve Act.

Cochrane first described what the problem isn't. He distinguished a credit crunch from a change in supply or demand of credit. In a credit crunch, borrower and lender preferences do not change, but something prevents the transactions from occurring, trapping the market at an artificially low amount of lending. He analogized a credit crunch to a situation where people want to buy corn, other people have corn to sell, but all the trucks are broken down. If the preferences of borrowers or lenders change, however, the market still reaches equilibrium; the change is that the equilibrium is at a lower level of lending. The takeaway is that a reduction in lending does not necessarily indicate a credit crunch. Banks may be unwilling rather than unable to make loans. During the question-and-answer period, a student asked the necessary follow-up: how do we know which is which? Cochrane indicated that the current situation is probably not a credit crunch because banks have access to money from each other and from the Fed, so the mechanisms are all in place. People just aren't using them.

The real danger, according to Cochrane, is political risk, the uncertainties of constantly changing rescue plans, and a "contagion" of bailouts that will do nothing to help the banking system. As the economist on the panel, he offered a forecast: new bailout plans every 72 hours. Politicians do not know when to quit, or even what to do (go to 3:37). He did not express confidence about the plans, including a proposal for a second fiscal stimulus package. Cochrane quipped, "The premise of a fiscal stimulus is that Americans do not borrow enough and do not spend enough. Enough said."

One source of the current problem, Cochrane continued, is bankruptcy law. While taking time to sort out all the obligations is fine for "Joe's Hardware Store," the system does not work so well for financial institutions. A bankrupt company should be quickly liquidated so others can make better use of its assets in the market. Baird, though not wanting to be defensive, rose to the challenge during his portion of the presentation and pointed out that Lehman Brothers went through bankruptcy in a single work-week, starting Monday and selling off assets Friday afternoon. Most financial instruments are not subject to an automatic stay, so they are not locked up for a long time. Cochrane wondered, if everything worked so well, why were so many people concerned about investment banks winding up in bankruptcy court. Baird admitted that many transactions will require the banks as necessary counterparties, which may actually tie them up in bankruptcy court for significant time.

Henderson drew a troubling comparison between today's political climate and the Great Depression's. First, Hoover and FDR raised taxes in the wake of the crash. Today, complaints abound about rampant deficit spending, and raising taxes is an obvious way to correct that problem. Second, the government implemented protectionist measures such as the famous Smoot-Hawley Tariff. Today, NAFTA's popularity has declined since the 1990s, and concern is widespread about jobs moving overseas. Third, many people "prosecuted and persecuted" those who have done well in this market. Today, commentators often blame greedy capitalists and decry golden parachutes and growing income inequality.

The solution is, of course, freedom. Free trade and lower (or at least not higher) taxes are a place to start. The government should let more institutions become banks; Wal-Mart, for example, wanted to enter the banking market a few years back. Increased immigration could absorb the excess housing in the market. (Henderson exclaimed, "I could break into a Neil Diamond song here.")

An alternative Neil Diamond song is "Thank the Lord for the Nighttime":

I'll talk about plans now Baby, I got plenty

Nothing ever seems to turn out the way it should

Talk about money, girl, I ain't got any

Seems like just one time I'm feelin' good

Full post as published by The University of Chicago Law School Faculty Blog on October 19, 2008 (boomark / email).