Another ideological god has failed. The assumptions that ruled policy and politics over three decades suddenly look as outdated as revolutionary socialism.
“The nine most terrifying words in the English language are: ‘I’m from the government and I’m here to help.’” Thus quipped Ronald Reagan, hero of US conservatism. The remark seems ancient history now that governments are pouring trillions of dollars, euros and pounds into financial systems.
By Gerard Caprio
The lack of clarity in the US Treasury’s plan to deal with the financial system is hardly unexpected. The administration is just one-month-old, and the specifics of this crisis, like many of its antecedents, are unique. As the plan becomes more specific, we can hope that the administration will be able to educate the public, including the supposed friends of free enterprise, that any plan for dealing with the banks must include the failure of those that are truly and deeply insolvent.
by Laurence Kotlikoff, Perry Mehrling and Alistair Milne
The infusions of equity in a score or so of major banks will help prevent a deep and prolonged world-wide recession. So will the Fed’s new Money Market Investor Funding facility, and similar guarantees provided in some other countries, which support unsecured short-term borrowing by top-rated financial institutions.
But these steps won’t help most banks to get back to their main job – lending to households and businesses. For banks to lend, they must borrow and doing so, on any scale, requires collateral. Collateral today is in terribly short supply because trillions of dollars in AAA or better senior structured credit securities, including top-tranche mortgage-backed securities, are no longer being accepted.
by Laurence Kotlikoff and Edward Leamer
The demise of financial titans and the incessant warnings of economic Armageddon have unleashed a tidal wave of asset sales across the globe, eviscerating trillions in personal wealth. Stock prices are now low enough to bring back some buyers, but the contest between fear and greed remains undecided.
The same defensive mentality that allowed the sale of equities at fire sale prices threatens to cause a sharp drop in consumer spending, which accounts for 72 per cent of US GDP. If this happens, the economy will slide into deep recession.
By Maurice Obstfeld, Jay C. Shambaugh and Alan M. Taylor
Since the early 1990s, central banks in many emerging markets and developing countries have accumulated foreign reserves at an unprecedented rate. The macroeconomic impact of these official flows has been profound and they have contributed significantly to global imbalances. Providing an explanation for these trends remains a major puzzle in international macroeconomics, and prevailing theories based on trade or debt deliver poor empirical performance. We argue that part of this great reserve accumulation is a response to the threat of financial instability in the context of rapidly expanding financial systems, increasingly mobile capital, and exchange rate objectives. The recent turbulence in global financial markets supports this view.
By Raghuram Rajan
We have a full blown panic in financial markets. Any but the safest assets are being heavily discounted. Policymakers have to be thinking in more radical terms than they have done so far to fight the contagion. But that is no reason to do the wrong thing.
There seems to be an impression that the real problem continues to be the liquidity of mortgage-backed securities. Hence the proposal to set up a government agency to buy these securities from distressed banks, akin to the role played by the Resolution Trust Corporation in the 1980s. There are concerns with this proposal. First, even though the illiquidity of the market for mortgage-backed securities, and the substantial markdown in prices of these assets, was responsible for the losses suffered by financial institutions, simply attempting to halt further falls in asset prices will not restore sanity to the financial system. The real problem is the financial system has too little capital. Buying assets at the current depressed market price will not help. And overpaying substantially for these assets will reward the shareholders of the most incompetent or risk-seeking banks, who hold the largest amounts of this now-toxic waste, with the most taxpayer dollars.
The remainder of this column can be read here. Discussion from our forum members and contributors appears below.
As my colleague, Clive Crook, has already noted in his blog on several occasions, the journalist, Michael Kinsley, has started a conversation on “creative capitalism”, the controversial idea advanced by Bill Gates at the annual meeting of the World Economic Forum last January. Michael was kind enough to invite me to contribute. In the end, most of what I wrote was about capitalism itself, rather than creative capitalism (whatever that may be).
My starting point was that one would not get very far in understanding how capitalism might be changed if one did not first understand what it was. In the end, I posted four pieces, which I hope will also be of some interest to readers of this forum. They are entitled “what makes profit-maximisation possible”, “what Bill Gates really means by creative capitalism”, “profit-maximisation as the sole goal of a corporation” and “corporate social confusion”. They can be found here.
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