Public Policy is Destroying Employment

The U.S. Treasury is now creating a massive Unemployment Insurance program: off the books, and without Congressional approval. As we know from decades of observing our friends in Europe, Unemployment Insurance raises the unemployment rate.

Specifically, the U.S. Treasury is spending $20 billion on Citigroup preferred stock. As part of the conditions:

"Importantly, the agreement calls on Citigroup to take steps to help distressed homeowners. Specifically, Citigroup will modify mortgages to help people avoid foreclosure along the lines of an FDIC plan that was put into effect at IndyMac Bank, a major failed savings and loan based in Pasadena, Calif. Under the IndyMac plan, struggling home borrowers pay interest rates of about three percent for five years. Rates are reduced so that borrowers aren't paying more than 38 percent of their pretax income on housing."

In other words, the Treasury mandates that Citigroup forgive homeowners in proportion to their lack of income. As I explained in my latest NBER working paper, this kind of forgiveness is already in banks' private interest, but it is not in the public interest. The Treasury is now reinforcing that socially-counterproductive bank policy.

I have worried about this privately for three weeks now. Last week I warned about this on my blog and in the NBER working paper. All other economists have been completely silent on this matter.

disclosure: long XLF