A Mold Problem

Tue, 28 Oct 2008 00:06:22 +0000

I read this article in my local paper over the weekend (which had the much more appropriate headline, "A Bailout Bonanza"). This is what government by panhandling looks like when all pretense that the activity is to be avoided is removed. Is there no use of future taxpayers' resources that is too wasteful for the government to pass up? Bruce Bartlett's point that we have failed to articulate what makes the financial sector different is looking smarter and smarter as time goes by.

To make progress, perhaps a different approach is needed. How is this problem in the financial sector not different than problems we already know how to address? From the home-repair-and-improvement category, I offer the following analogy:

You get mold in your house when you have lots of moisture and poor circulation. Some moisture is unavoidable, but the two of them together will cause mold to grow. Mold in your environment can cause any number of health problems. Think of leverage as the moisture and the combination of distorted private incentives and lax public regulation as the poor circulation.

When you want to get rid of mold, you have basically two options. First, you can scrub it really hard with some strong disinfectant. You would apply this remedy if you knew there were parts of the contaminated area that are salvagable and you could clearly see where the mold is and where the mold isn't. It would be an ineffective remedy if you used mild disinfectant or stopped scrubbing before the mold was gone. Think of the original Treasury proposal in this way -- buying toxic assets directly off of bank balance sheets. It can be done well, but only under the right circumstances. I don't think we have those circumstances here -- there seems to have been little progress in differentiating good pools of securities from bad ones. Under these circumstances, the TARP plan is like throwing bleach at the wall and praying for a good outcome.

Second, you can remove the parts of your house that have mold in them and replace them. Expect to be without the use of some parts of your house for awhile. Expect to be inconvenienced. But if you have a decent contractor who knows what he's doing, your house can make a full recovery. Think of a proactive FDIC that closes down insolvent banks and equity injections by the Treasury into healthy banks in this way. Like the first option, this will cost you some money up front. But if you spend enough, you are sure to fix the problem. Unless you have money to burn, it would be wise to try to pay as little for the repairs and cleanup as you can. If the FDIC is too timid or too slow, or if the Treasury secures too little in return for its capital, then this remedy can get very expensive very quickly.

It seems like we're going with a weak version of option #2, with the hope that we also move in the long-term to curb the moisture and improve air circulation. I suppose that's better than the approach that got us into this mess -- putting up wallpaper over the mold wherever we see it starting to form.