Berkeley Lunch on the Financial Crisis
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The Mercury News Interview: Brad DeLong

The Mercury News interview: Brad DeLong, Cal economics professor: By Elise Ackerman

Congress' consideration last week of a $700 billion bailout of the financial industry left many wondering just how bad the economy could get. President Bush and Treasury Secretary Henry Paulson both predicted dire consequences if the bailout weren't passed. Mercury News reporter Elise Ackerman asked Brad DeLong — an economist at the University of California, Berkeley, and a former deputy assistant secretary in the Treasury Department under President Clinton — what the bailout proposal means for Main Street. Is there light at the end of the tunnel? How bad can it get? And what is likely to happen to the housing market?

Q: What's the most important thing an ordinary person needs to know about the bailout plan Congress was considering this week?

A: It is not supposed to be a bailout plan. The idea is to make sure that the shareholders of banks and institutions that made stupid and unwise loans suffer enormously in terms of losses of wealth while still preserving the flow of funds through the financial sector to the real economy so that companies can create jobs.

Q: So they will suffer?

A: The CEO of Bear Stearns lost 95 percent of his personal portfolio in the forced merger of last March.

Q: What do you think of this plan? Is it what needs to be done?

A: I think the Paulson-Dodd-Frank plan as it is emerging is much, much less effective than it could be. But it is still much better than doing nothing, which is kind of like being poked in the eye with a sharp stick.

Q: Are there still things the government could do that would be more effective?

A: Yes, I think something like the Swedish Plan — by which the government invests in the major banks of New York and elsewhere and essentially takes them over and runs them for a few years, and then when they become profitable again sells off its stake to private investors — would be much more effective and a much better use of the public's money. Indeed, that's why the Swedes did it when they faced a similar crisis back in 1992.

Q: Some people are questioning whether there is really a crisis. Is the situation really as dire as it has been painted?

A: In the second quarter of 2007, $300 billion moved through financial markets into businesses. The businesses borrowed that money in order to expand employment. That number was halved by the second quarter of 2008. The third quarter of 2008 is sure to be less and the fourth quarter of 2008 may be zero. If you want to have an economy with a growing number of jobs, if you want to keep the jobs we have, you've got to keep the flow of funds through the financial markets from savers to businesses going. At the moment it isn't.

Q: How bad are things likely to get?

A: (With the Paulson plan the) unemployment rate will top out between 8 and 10 percent this business cycle. And (without it) the unemployment rate will be higher, but we don't know how much higher.

Q: What does that mean in terms of numbers of people who will be without jobs?

A: Each percentage point of unemployment is something like an extra 1.5 million people who have lost their jobs and can't find another one.

Q: What about the housing market? Is this likely to help stem the decline?

A: Housing prices are still a bunch higher than they were in 2000 and are probably coming down another 10 or 15 percent. The decline is likely to be a lot worse if the economy goes into depression than if it just stays in recession.

Q: Are we in a recession already?

A: I would say yes. Jim Hamilton at the University of California at San Diego, who is my guru in such matters, said there is a more than 95 percent chance that we are in a recession. And I think when they decide when the recession was, they will stay in started last December.

Q: There have been various ideas floated about how to stop the decline of the housing market. Why can't the government simply agree to take over the troubled mortgages that are currently in default?

A: This is indeed one of the plans, to revive the Federal Homeowners Loan Corporation that we had during the Great Depression. The problem is, it's very hard to design such a program that doesn't give away a lot of money to mortgage lenders who shouldn't have made the mortgages in the first place, or to home purchasers who didn't save but instead spent their incomes on other things thinking someone would rescue them if they got into trouble.

Q: Why not declare a moratorium on foreclosures?

A: If you do that, can I stop paying my monthly mortgage payment and still stay in my house? I could get an extra $2,000 a month to spend. ... It would create bigger problems than it solves because those mortgage payments ultimately flow back to investors of all kinds, state and local governments, pension funds and so forth.

Q: What steps can be taken to prevent this from happening again?

A: The first step would be to say you can't trade a derivative security without trading it through an organized derivative exchange. That is to centralize the market and make it transparent for finance, to re-regulate it in a bunch of different ways. The second thing is to say if you are a high-end financial professional or you are getting a high income from anybody, that you have to take a great deal of that income in the form of long-term stock in whatever company is paying you. So if you are giving the company bad advice, you shouldn't be away on the beach, happily living the life of Riley.

Q: Are taxes going to go up?

A: Taxes might go up a tiny bit. But our taxes are going to go up a lot more if the unemployment rate goes up to 10, and all the extra workers who now pay taxes don't and we have to shoulder their burden.

Q: So it sounds like it is actually not such a grim scenario. Unemployment goes to 10 percent and home values fall between 10 and 20 percent and then we start recovering.

A: It depends on whether you are one of those unemployed or not, if you are one of those foreclosed or not, how grim it is. Even if you are not unemployed, a labor market where there is 10 percent unemployment, you have to pay a lot more attention to your boss and accept a lot lower rates of real wage increases than you do when the unemployment rate is 5 percent. It is a different economy.

Q: Once the economy starts to grow again, will things get better?

A: Things are likely to get better. They always have.

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