Fast recapitalization, removing the signaling penalty by having the government require banks to stop giving dividends in the short run … those are the kind of policies that economists have been discussing, fleshing out, and encouraging over the past two weeks. Of course, the challenge to those proposals is that the parties who end up paying are precisely those firms and industries that are politically powerful.
The public choice economics lesson in this? Mancur Olson was right about concentrated benefits and diffuse costs:
… large groups will face relatively high costs when attempting to organize for collective action while small groups will face relatively low costs. Furthermore, individuals in large groups will gain relatively less per capita of successful collective action; individuals in small groups will gain relatively more per capita through successful collective action. Hence, in the absence of collective incentives, the incentive for group action diminishes as group size increases, so that large groups are less able to act in their common interest than small ones.
The book concludes that, not only will collective action by large groups be difficult to achieve even when they have interests in common, but situations could also occur where the minority (bound together by concentrated selective incentives) can dominate the majority.
Alex Tabarrok has done us all a great service with his post aggregating and summarizing the proposals from a variety of economists:
The consensus among economists is now clear, the best strategy for dealing with the financial crisis is to recapitalize the banks that need recapitalization. Paul Krugman, John Cochrane, Luigi Zingales, Douglas Diamond, Raghuram Rajan and many others all advocate some form of recapitalization as do Tyler Cowen and myself. Krugman would prefer a recapitalization in the form of nationalization. In my view, there is still plenty of private money to buy banks at the right price and my preferred model is the FDIC leading a speed bankruptcy procedure, as was done brilliantly with Washington Mutual (Cochrane also supports this model.) In the middle are most of the others who have a variety of good ideas to require the banks to raise equity in various ways.
Sadly, I fear it’s too little too late. It’s not too little because of the lack of substance in the recommendations; I have read all of the above and can support the core ideas they have in common. But it’s too little because it’s up against all of the concentrated financial industry and business lobbying that I mentioned in last night’s post.
It’s also worth pointing out that Wells Fargo is buying Wachovia in its entirety, which means that this salutory recapitalization is already happening. Policies that facilitate this kind of activity that is already occurring are much, much better than the proposed bailout.
Oh, and I’m still angry and disgusted.