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Professor, former Dallas Fed director offers insight into bailout legislation
[October 02, 2008]

Professor, former Dallas Fed director offers insight into bailout legislation

(Waco Tribune-Herald (TX) Via Acquire Media NewsEdge) Sep. 30--After the U.S. House stunned many by voting down Monday's proposed $700 billion bailout of faltering financial institutions, Baylor University economics professor Kent Gilbreath spoke to the Tribune-Herald about potential legislation.

Gilbreath is a former member of the board of directors of the Federal Reserve Bank of Dallas.

QUESTION: Is government intervention necessary at this time?

ANSWER: What a huge question. It's certainly not the end of the world that this legislation didn't pass. In fact, it's questionable whether it was needed at all. It may be needed, but it's a little early to tell at this point.

The evidence of whether it is needed or was needed will become clearer in the first two or three weeks of October, when we see to what extent credit availability to businesses and consumers has dried up. If there is a reasonable flow of credit to businesses and consumers, then it may be that we never needed any legislation to keep the economy from falling into a deep hole. However, if credit is to dry up for car dealers, furniture dealers, appliance dealers and other consumer durable goods businesses, it may be that we discover that this legislation was critical, and we may have to revisit implementing it.

The financial crisis is indeed about to spill over into the real sector of the economy, and joblessness will grow, new home starts will remain low, layoffs will increase, business sales will go down, many small and perhaps some large businesses will go broke. These activities are all typical of any recession. I do believe that this is not going to be a typical recession, that it's going to be deeper and longer than more recent recessions because the foundation of our economy has serious problems that have been building up over the past 10 to 15 years and have all come together at this particular time.

Q: Was this push for legislation too hasty?

A: Yes. The proposed legislation was hastily conceived and, after reading it last night, I found that it contained many things that were not needed, in my opinion, of course, and it was not at all clear to me if it would even help if it were passed. It may be that we need that kind of legislation, but I'm not sure that, if it passed, it would even do any good because the economy is barrelling toward a serious recession, and an easing of the availability of credit may not deter us from this difficult path we're on.

Q: If you were approached for advice, what would you propose as the best route?

A: I think that we do need to extensively re-examine the regulation of financial institutions and move toward greater regulation of these financial institutions, but do so only after very careful and thoughtful consideration of the best ways to regulate financial institutions.

I want to add a little bit more to that. It's not so much that we don't have good financial institution regulations on the books. It's primarily that they have not been enforced and that the financial institutions have found ways around those regulations that may be legal but are particularly hurtful to the economy. I could give you a lecture on that one.

Financial institutions, financial markets are like rivers -- if you build a dam, they'll try to go around them. And even if they are legally around them, it may still be pretty hurtful to the economy.

It's not the subprime mortgages that have caused the problem. It's the way in which those mortgages were given and then subsequently packaged into structured investment vehicles and collateralized debt instruments. In other words, it wasn't just the lending of money, it was the way it was lent and then the way those loans were packaged and sold. So it's really unsophisticated to say the subprime mortgages caused the problem. It really wasn't the mortgages themselves, it was what was done with them.

Q: If legislation were passed, when and how would it affect Central Texas?

A: That's the issue, we can't really know that it will affect either Central Texas or anybody, for that matter.

I'm going to give you an analogy: When I was at the (Federal Reserve Bank of Dallas), we had this understanding that we were really good at fighting inflation, but we were not so good at fighting recessions and depressions. In other words, we could fight inflation because we could tighten up on the money supply or reduce credit. But if you ease up on the money supply to stimulate the economy, if you make credit readily available, it may not work. And the answer is the old phrase, 'You can lead a horse to water, but you can't make him drink.' In other words, you can make the credit available to businesses and people, but you can't make them borrow. If they think that the economy is headed into a tailspin, they're not only not going to borrow, but they're going to pay off loans that they have so that they reduce their indebtedness and their exposure to the recession.

So I'm not sure that even easing up on credit availability through any legislation would have any kind of a short-term stimulative effect that would carry us out of the recession we're heading into.

FDR said, 'The only thing we have to fear is fear itself,' and he was really talking about people being afraid that we were going into a depression and not spending and that fear would cause that depression they were afraid of to happen when they stopped spending.

So what we've got here is another 'fear itself' phenomenon. Everybody is concerned, and consumers and businesses, everyone who spends money, is going to think twice about spending it and think thrice about borrowing money to spend. Government can't always stimulate us out of recessions.

One thing that I think would be good to mention is this: Right now, the most important financial asset that everyone has is their jobs.

If you do whatever it takes to keep your job, you can worry later about whether or not to incur additional debt. But keeping your job is just absolutely critical right now. People don't think of jobs as financial assets, but they are the largest cash flow to everyone except the very rich.

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