In their handling of the credit crisis, the Treasury Department and Federal Reserve have repeatedly been criticized for their lack of transparency. The decisions as to which financial institutions to bail out have been made behind closed doors, the complaint goes, and Treasury Secretary Henry Paulson's original plan for the $700 billion bailout was only three vaguely-worded pages long. But I wonder if this criticism isn't exactly backwards. It seems to me that the Fed and Treasury have been too transparent, and that this could be contributing to the crisis.
Take the bailout of Bear Stearns in March and the decision not to bail out Lehman Brothers six months later.
The decision to let Lehman fail is now widely criticized, and a standard criticism is that the Fed and Treasury sent mixed signals about what they were going to do- that is, they weren't transparent enough. But it seems to me more accurate to say that the Treasury and Fed had sent very clear signals- they had signaled that they would bail out major investment banks that threatened to fail. The biggest problem was that they made the implicit promise, then violated it, taking everyone by surprise.
The $700 billion bailout is a still more troubling illustration. Initially, the Treasury very clearly announced that the government would spend the money buying mortgage related securities from banks and other financial institutions. Treasury then changed its mind and decided to invest directly in banks, and this week has proposed to support consumer borrowing. With each shift, investors have panicked, concluding that each of the Treasury's plans has been a failure and that the shifts mean that Treasury is going back to the drawing board.
If the Treasury didn't feel the need to announce in advance precisely what it planned to do, there might be more flexibility and less of a sense that each shift in focus reflects a failure of the earlier plan. The markets might not be quite so volatile, in other words, and the government might be making more progress on addressing the crisis, if it weren't forced to be quite so transparent.