Many economists believed that the heart of the government's initial plan to pay $700 billion for toxic assets was aimed at the wrong target. Purchasing mortgage securities from banks wouldn't do anything to kick-start lending and get credit flowing again, they said. Rather, banks would use the proceeds they got from the Treasury to pay off debtors, and those debtors would use the proceeds to buy safe assets.
They said a wiser course -- the one the Treasury now seems to have come around to -- was for government to rebuild the badly depleted cash levels on bank balance sheets. That would cushion institutions against future losses, giving them the wherewithal to lend again. Other hitches in the original plan include coming up with a price for mortgage securities that is above the "fire sale" level they would draw on the open market, but not so high that taxpayers end up getting taken for a ride.
The Treasury move is a sign of how, as international efforts to contain the crisis continue this weekend at meetings of the International Monetary Fund and World Bank, economists' ideas for solutions are influencing policy and entering the public discourse.
Hat tip (not surprisingly) to Mankiw, who says "score one for the ivory tower."
Near the end of the General Theory, Keynes wrote: "Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back." Perhaps we should make that: "blogger of a few days back."
That's the sentence immediately after the one I cited in this recent post, noting that the Congressional modifications to the proposal included opening the window for an equity component which Paulson is now jumping through (nice work, Senator Dodd).
Here's the quote in context, which closes the General Theory:
At the present moment people are unusually expectant of a more fundamental diagnosis; more particularly ready to receive it; eager to try it out if it should be even plausible. But apart from this contemporary mood, the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated with the gradual encroachment of ideas. Not, indeed, immediately, but after a certain interval; for in the field of economic and political philosophy there are not many who are influenced by new theories after they are twenty-five or thirty years of age, so the ideas which civil servants and politicians and even agitators apply to current events are not likely to be the newest. But, soon or late, it is ideas, not vested interests, which are dangerous, for good or evil.Keynes continues to be very relevant.