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Pavlov For Bailouts

Over at TPMCafe, Elizabeth Warren has a new theory to throw into the bailout ring: At a Harvard panel discussion yesterday, economics professor Ken

Cashinhand Over at TPMCafe, Elizabeth Warren has a new theory to throw into the bailout ring:

At a Harvard panel discussion yesterday, economics professor Ken Rogoff made an interesting point: The liquidity crisis isn't real. Or, to restate it: Any liquidity crisis is caused by the promise of a government bailout. Ken said that his many friends in investment banking said that there is plenty of money to invest in financial services, but right now it is "sitting on the sidelines." Why? Because the financial services industry does not want to pay the terms demanded. As he put it, why do business with Warren Buffett who will negotiate a tough deal, if you believe that the government will ride in soon with cheaper cash?

Now, I think Rogoff is exaggerating some here - waiting for a bailout is not the sole cause of the problem, because the problem was there before anyone talked of a bailout - but he has some goodly part of a point now that a bailout seems imminent.

And this is partly why only a bailout "in exchange for equity stake" plan makes any kind of sense. Once they're faced with losing sizable amounts of their company shares to the government as stakeholder, we'll see that Rogoff is partly right and financiers will suddenly decide that some of their "toxic debt" isn't so smelly after all if they're going to be punished for offloading it. Then, if the bankers think they can make more money for themselves from using their own money to inject liquidity into the system than by letting the government do it at a cost in shares, we'll see credit markets unfreeze some of their own accord. It's like Pavlovian conditioning for financiers.

That in turn means any rescue attempt - which I still think has to happen in some form, although I favor Bernie Sanders' version - can be smaller and fits perfectly with the Dem plan to allocate money in tranches.

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