Summers overplays stimulus, silent on zombie bank drag

August 4, 2011

By Benn Steil
The opinions expressed are his own.

Reuters invited leading economists and writers to reply to Larry Summers’ op-ed on his reaction to the debt ceiling deal. We will be publishing the responses here. Below is Steil’s reply. Here are responses from Laura Tyson, Russ Roberts, Donald Boudreaux, Robert Frank and James Pethokoukis as well.

Larry Summers expresses relief, cynicism, and anxiety in the wake of the debt deal. I second these emotions. Whereas those elected to the House on a hardline anti-tax, anti-spending platform had every right to press for their policies, threatening to push the country into a catastrophic default if the democratically elected Senate and president didn’t give them their way was reprehensible. Mind you, these congressmen were some of the same folks who backed the 2005 Bankruptcy Reform Act on the grounds that default was a form of moral turpitude.

I suspect that Larry still overestimates the stimulus (or “fiscal multiplier”) effects of temporary government spending and tax cuts, though his suggestions — in particular, extending the payroll tax cuts — are hardly outlandish. What concerns me is that the Administration believes, and Larry’s silence suggests he believes, that we’ve done all that needs to be done to fix the structural problems in the financial sector that are still weighing the economy down.

There are real dangers lurking in the breakdown of a major part of the credit transmission mechanism. Large corporations, like IBM, that can bypass the busted banking sector and issue securitized debt are clearly benefiting from record low borrowing costs. But small- and medium-sized companies have always been dependent on small- and medium-sized banks, whose balance sheets are still cluttered with the detritus of soured loans. These banks will not lend, except on vastly greater collateral and at much higher real interest rates than before the bust. Little recognized is that the firms, for their part, have for years relied overwhelmingly on real estate for their collateral, the value of which has been badly impaired or obliterated. So a zero Fed funds rate is doing little for them.

I still believe it was a mistake that TARP did not ultimately include an element to extract impaired assets from bank balance sheets — particularly those of smaller institutions that are the backbone of nonsecuritized business lending. Government equity injections are not enough; banks consider them politically toxic, and therefore have focused on disgorging them at the earliest opportunity.

Previous U.S. administrations recognized the importance to economic recovery, at home and abroad, of moving aggressively to repair or resolve zombie banks. Macroeconomic interventions such as payroll tax cuts, extended unemployment insurance, or even another round of Fed quantitative easing are not enough given the nature of the financial crisis we’ve just been through.


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Good points. I think the feds should have also forced the banks to refinance mortgages to straight 30@5% loans as soon as the meltdown started. It would have been painful and pi$$ed off the (at that time) stable and responsible borrowers but many of these folks ended up getting sucked into the abyss anyway as businesses started failing. The banks and the rest of us would be in better shape now if they had found a way for people to keep making their house payments.

Posted by SGinOR | Report as abusive

[…] deal. We will be publishing the responses here. Below is Tyson’s reply. Here are responses from Benn Steil, Russ Roberts, Donald Boudreaux, Robert Frank and James Pethokoukis as […]

Posted by It’s all about the jobs | The Great Debate | Report as abusive

[…] publishing the responses here. Below is Hamilton’s reply. Here are responses from Laura Tyson, Benn Steil, Russ Roberts, Donald Boudreaux, Robert Frank and James Pethokoukis as […]

Posted by Assessing the debt ceiling damage | The Great Debate | Report as abusive

Alan Greenspan suggested not bailing out the banks and instead give monetary and tax incentives to banks in return for keeping people in their homes by using interest rate and or principal reduction. A sort of indemnification as it were. In light of the drop in the real estate market this was economically a prudent idea. I doubt seriously if any one crunched the numbers to see if it were feasible. Our government rejected that idea. Now we have millions of homes standing vacant being vandalized while the ranks of the homeless continue to grow.

Posted by coyotle | Report as abusive

[…] deal. We will be publishing the responses here. Below is Tyson’s reply. Here are responses from Benn Steil, Russ Roberts, Donald Boudreaux, Robert Frank and James Pethokoukis as […]

Posted by It’s all about the jobs | JavedanTV | Report as abusive

good points

Posted by Robertla | Report as abusive

The harvesting of copper from vacant homes is part of the social dysfunction in our society of the haves and have not’s. Most likely unemployed construction works who have the understanding of the system and the difficulty the banks have monitoring the millions of vacant homes in the United States abandoned by discourage and unemployed American workers. Bank of America in 2009 hired individual to go to homes in default to determine if actual people were in the homes and were they the right people to be there. Maybe should have sent a banker.

Posted by mward1921 | Report as abusive