President Obama's speech :unblocking credit

February 24, 200911:50 p.m.

President Obama delivered an excellent speech to Congress this evening which promised action on a wide range of fronts from health care, education, energy, defense and the economy. It was sober ambitious and optimistic setting an appropriate tone for the circumstances.

One of the greatest challenges that the President faces is the problem of unblocking credit. So far despite the expenditure of 350 billion dollars in bailing out the banking sector with TARP funds, this first phase of financial aid to the banking sector delivered under the Bush administration did not do the job largely because of the lack of stringent conditions on what the recipient banks could do with the money. This needs to be corrected in the next phase of the operation.
Joe Stiglitz, a Nobel prize winner, has just commented on CNN that it would have been better to write off these failing bank institutions allowing them to go bankrupt and use the 700 billion dollars in TARP funds to set up an entirely new bank presumably under state control which with 10 to one ordinary banking leverage could have extended 7 trillion dollars of new credit to the economy. This is an appealing alternative at first glance, particularly for those who want to punish irresponsible and greedy bankers.It would have had vastly more political appeal than a program that appeared to benefit bankers, a group that few people are terribly fond of.

However the problem would have been that the collapse of the existing banks would have unleashed a potentially catastrophic wave of bankruptcies and financial panic that probably would have destroyed the financial sector even more substantially than the current circumstances have badly damaged it. So while Stiglitz has a point about the government being taken to the cleaners by the banks in the first round of TARP he needs to rethink his proposal and explain how one can avoid the system and society damaging consequences of the policy he is proposing.

The medical warning do no harm modified by the Pareto optimizing credo plus   Kaldor -Hicks compensation adjusted for the problem of moral hazard needs to apply.Collateral damage could be enormous. Nevertheless, future help for the banking sector absolutely must guarantee the unblocking of credit and strict supervision over how the monies are spent.