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“The Banks” versus “Some Banks" by Paul Krugman

April 2, 2009 - By New York Times Writer Paul Krugman

On the run: this critique of my views is interesting. But I think there’s a crucial assumption that isn’t right. The question isn’t whether “the banks” are insolvent; most surely aren’t. Instead, some banks are probably insolvent.

So it’s not the case that the costs of the PPIP are costs we’d have to bear one way or another; there’s a lot of money going to institutions that would never otherwise arrive at the taxpayers’ door.

And that, in a broad sense, is what’s wrong with TARPish rescue schemes. They try to fix the banks by driving up the price of a whole asset class. Most of those assets are NOT held by the probably insolvent banks. So it’s a diffuse, inefficient way of tackling the problem — a taxpayer subsidy to basically anyone holding ~~toxic waste~~ legacy assets, rather than a direct infusion of funds where needed. Contrast it with what the FDIC does when it moves in: it doesn’t shower money on banks in general, hoping that this will solve the problem; it seizes banks that are in trouble, and recapitalizes them.

To justify the scheme as announced, you have to either assume that the toxic assets are wildly underpriced, or take as a given extreme political and legal constraints preventing you from doing anything close to the right thing.

And about those legal constraints: it’s funny how GM is being treated as a ward of the state, even though it hasn’t formally declared bankruptcy, in a way that AIG — which is 80% government-owned! — is not.