This behind-the-scenes account of the financial crisis by Phillip Swagel, the former Assistant Secretary for Economic Policy at Treasury, makes for absolutely fascinating reading. Swagel takes academic economists to task for their failure to understand the very real legal constraints on policymaking. This is something I've emphasized with regard to the ridiculous debate over "nationalization" or "managed receivership" of money center banks. As Swagel writes:
A lesson for academics is that any time the word "force" is used as a verb ("the policy should be to force banks to do X or Y"), the next sentence should set forth the section of the U.S. legal code that allows such a course of action—otherwise, the policy suggestion is of theoretical but not practical interest.Preach it, brother. Similarly, Swagel shoots down Luigi Zingales's widely-cited (but comically impractical) proposal to force banks' bondholders into a debt-for-equity swap:
As Zingales (2008) notes, debt-for-equity swaps could "immediately make banks solid, by providing a large equity buffer." All that would be required, according to Zingales, would be a change in the bankruptcy code. A major change to the bankruptcy law was enacted (for better or for worse depending on one’s point of view) with the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, but this was the culmination of years of legislative debate. The idea of a further instantaneous change in the bankruptcy code was unrealistic. Indeed, efforts to make such changes in the middle of the crisis would have re-opened the debate over the 2005 Act along with controversial provisions such as the mortgage cram down. The simple truth is that it was not feasible to force a debt for equity swap or to rapidly enact the laws necessary to make this feasible. ... [T]he idea … that there should be a forcible capital injection [is] pure ivory tower, unfettered by the practicalities of legality, enactment, or implementation.This same critique applies to Simon Johnson's absurdly unrealistic suggestion that the Treasury could use its proposed resolution authority for large financial institutions to deal with the current financial crisis. Most nationalization/receivership proponents seem to think that major changes to the U.S. legal code occur instantaneously, which betrays a stunning ignorance of the legislative process. Swagel also pushes back against the criticism—advanced most prominently by TARP watchdog Elizabeth Warren—that Treasury overpaid for its equity stakes in the banks:
An important consideration with regard to the terms of the capital injections was that there is no authority in the United States to force a private institution to accept government capital. This is a hard legal constraint. ... In order to ensure that the capital injection was widely and rapidly accepted, its terms had to be attractive, not punitive. ... The terms of the CPP were later to lead to reports that the Treasury had "overpaid" for its stakes in banks, which of course is the case relative to the terms received by Warren Buffett. But this was for a policy purpose: to ensure broad and rapid take-up.Read the entire essay. It's well worth the time.