The economists forum at FT.com has a shorter version of MIT economist Ricardo Caballero’s arguments for direct action to restore confidence by comprehensive public insurance, and by strict (and intrusive) government supervision while this insurance is in place. I am persuaded this policy will work, but like Luigi Zingales’ “Plan B” the idea doesn’t seem to be gaining any traction because it helps everyone. Thus there is no natural special interest to lobby for passage.
I would like to see more details on price discovery of the insurance — but both this article on last weeks VoxEU essays say only this:
With some dismay, I read that an enormous amount of time is being spent discussing what should be the price of the insurance and the first-loss threshold. It seems to me that given the extreme severity of the crisis and the asymmetries involved in failing in one or the other direction in each of these issues, the answers are rather obvious: The price of the insurance should be very low – say risk-neutral pricing plus 20 or 50 basis points of markup; and the first-loss threshold should be sufficiently low that no new capital will need to be raised in the short run if a loss arises.
The second intervention of Citi offers a micro-model of such an intervention, but it needs to be scaled up within each bank and massively across all banks and other key financial institutions. It also needs to be made much more attractive to all systemic financial institutions, even those that are not in deep distress.
What about the taxpayers? The best that can happen to all of us is that the financial crisis ends as soon as possible. This is the first priority, the rest can wait. If the transfer to the financial institutions ends up being too large for society’s taste, then it is always possible for the government to undo some of it through ex-post taxation of excessive earnings. Conversely, if the transfer is too low (the price of the insurance and the first-loss threshold too high), it may well be that we do not get another chance, at great cost not only to financial institutions but also to taxpayers.
Is Prof. Caballero saying that the US government is discussing what should be the price of the insurance? Or is he referring to the UK intervention? If the former, that at least indicates some level of awakening!
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