So what to do? We don't want to let the banking sector collapse into bankruptcy--Lehman Brothers was bad enough, and we don't want to replicate the Great Depression. But we also don't want to repeat Japan's mistakes of the 1990s, with zombie banks neither alive nor dead failing to do their job for the economy as they focused on getting back above water to create some value for shareholders and executives.
And here is my worry about the current plan to buy preferred rather than common stock of the banks. Preferred stock runs a risk of creating zombies--if shareholders and executives conclude that the preferred has all the equity value if they continue business as usual, then they will not continue business as usual but will instead start behaving like the Japanese banks of the 1990s. And we don't want that.
By mighty spells the Head Voodoo Priest Henry Paulson has raised the corpses of America's biggest banks from the graves to which the financial crisis was consigning them, but has he restored them to life, or just to zombiehood? Will they do their job for the economy, or will they begin wreaking destruction, all the while crying out: "BBRRAAIINNS! BBRRAAIINNSS!"
[NB: That's a funnier way of expressing my point below about changing forward-looking behavior. I'd rather hear that my worries are the uninformed results of undereducation in economics, but I still like hearing from Brad DeLong that I've kind of understood something relevant to the current mess correctly..]
And certainly it’s got to be much easier, much more comfortable, to give your self-selecting audience precisely what they want to hear and bask in their accolades. I don’t know if I’ve named it here before, but I’ve long observed a phenomenon in the blogosphere I call “audience capture,” where a once-interesting writer becomes rather dull and predictable, each post another jab at the lever, predictably rewarded with a tasty pellet.
For what it's worth, that phenomenon is one reason why I've never turned comments on. I do think that comments sections sometimes provide all the wrong kinds of feedback to a blogger.