Because the U.S. Treasury bailed out and backstopped banks (by injecting equity into them in late 2008, and later committing to provide public capital to any banks that failed the stress tests and could not raise private capital), the U.S. unemployment rate was lower at the end of 2010 than it would have been without these measures.Regular readers know that bailing out and bankstopping the banks are policy choices made after adopting the Japanese model for handling a bank solvency led financial crisis. Under the Japanese model, policies are adopted to preserve bank book capital levels and effectively transfer the losses from the excesses in the financial system onto the real economy.
The alternative is the Swedish model for handling a bank solvency led financial crisis. Under the Swedish model, banks absorb the losses today on the excesses in the financial system to protect the real economy. Subsequently, bank book capital is restored through a combination of future retained earnings and equity issuance.
The economists response to the statement were:
27% Strongly Agree
When weighted by the confidence of the economists in their response, the results were:
43% Strongly Agree
The bottom line: economists agree that adopting the Japanese model and its policy prescriptions was beneficial. But why did the economists overwhelmingly support adopting the Japanese model?
Here are some of their responses:
"Macro performance depends partly on credit from banks, which would have otherwise been impaired. Europe has a related growth issue now." Darrell Duffie, Stanford
"If the banking system had collapsed, unemployment would certainly have been higher in 2010". Pinelopi Goldberg, Yale
"The fact it was necessary doesn't mean we should be happy about it." Austan Goolsbee, ChicagoIn short, the economists either did not know that the Swedish model existed and had been shown to be successful or they ignored it.
"It is hard to imagine the mess we would still be in if most of our large banks had failed." Richard Schmalensee, MIT
"The question presumes Paulson’s forced alternative. If the only choice is between evil and Armageddon, evil might look ok." Luigi Zingales, Chicago
One reason that the economists may have ignored the Swedish model was they might not have known that an insolvent bank can continue to operate until it is closed by regulators. Banks can do this because they have both their deposits guaranteed by the government (this stops a run on the bank) and unlimited liquidity from the central bank (which is willing to lend against good collateral).
In the late 1980s, the US Savings and Loans were an example of banks that were insolvent (the market value of their assets was less than the book value of their liabilities) that continued to operate and support the real economy (in fact, they were very aggressive in supporting the real economy in terms of lending on commercial real estate in a bid to gamble on redemption).