Monday, September 29, 2008

Slapping the Invisible Hand: Financial Crisis and Government Bailout

Need a fast analysis of the current market crisis--which might not be a crisis at all--and government bailout? You might like to read this superb article on government intervention in the financial markets written by Joseph Calhoun, a chief investment officer for a investment company. One important point:

If this bailout goes ahead in its current form and the Treasury pays a high enough price to recapitalize the troubled banks, what has been accomplished? The plan may be enough to induce the banking sector to start lending again, although frankly, I don’t know why we would want institutions who have shown such poor judgment in the past to stay in that business. This plan short circuits the capitalist model which would allow the stronger, well-run institutions to gain market share and/or expand profit margins. The long-term effect will be to lower the overall return on capital in the financial services industry. The government apparently believes that the key to economic recovery is to allocate limited resources in an inefficient manner. Does that make sense?

The same author wrote another article last week with a historical backgrounder of what brought this crisis to a head, including a brief but insightful analysis of the effects of the "mark to market" accounting rule.

The "mark to market rule" (FASB 157) impacts balance sheets in an artificially negative way. It requires that certain assets have to be valued at the price you could get for them if you sold them right now on the open market. Sometimes, there is no market—not for toxic investments like collateralized debt obligations, or CDOs, filled with subprime mortgages. If there is no market, FAS 157 says, a bank must mark the investment’s value down, possibly all the way to zero. Wikipedia has an excellent explanation.

2 Comments:

Anonymous Anonymous said...

The article is armchair BS taking pot shots at regulators and offering nothing in its place except blind faith (and likely already stocked offshore accounts). The "top dogs" always do well when the market is left alone -- I thought you knew that from your blog slogan.

The trouble is what happens to the rest of the poor and huddled masses as the market does its work. Economists and investors are not very interested in those casualties of market adjustments -- that is just excess friction that is a necessary expense of the market doing its magic.

The market is never fully free - ever. The England of Adam Smith had the Royal Navy and a very good mechanism for collecting taxes. More generally, to have a market transaction, for example, you need to assume some court or related authority to enforce that transaction. The issue is always how big and extensive the government infrastructure is to be.

If you want to see examples of the UofC's free market effort put into practice in real countries, talk to the people in Chile or Argentina -- but you can only talk to the ones who lived through it! Tens of thousands did not live to give thanks to Milton Friedman.

Sure, Bernanke and Paulson can and should be criticized for their somewhat ad hoc approach to current problems, but to argue that they are behind this is the height of arrogance -- and also intellectually very lazy.

No theory, including the theory of the "invisible hand", is worth sacrificing the lives and well-being of large numbers of individuals in the name of ideological purity and the incomes of the top .1% of the economy.

Besides, you have always claimed to be so smart -- can't you realize a sales pitch when you see one? Look at the article again.

Sep 29, 2008, 10:11:00 AM  
Blogger Publia said...

I never claimed to be smart. I have not argued that Messrs. Benanke and Paulson have created this mess. I don't think we are sacrificing any lives for ideological purity here, nor do I have any axe to grind with regulators. A question for you: why would you bother to put this much time into commenting on a blog whose author you believe to be arrogant and intellectually lazy? What is your motivation? All that being said, You might enjoy seeing this video.

Sep 29, 2008, 12:35:00 PM  

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