UPDATE: Here is a pretty good primer on how the meltdown happened. It was those physics PhDs.
There is an interesting column today by Holman Jenkins that speculates on what might have been done about the financial crisis last year.
Letting the technical matter of keeping the banks afloat become a political football was a terrible idea. Letting our willingness to deploy giant sums of taxpayer money become the measure of credibility was a disaster. Letting all this be sold on Capitol Hill amid shrieks about the country collapsing into a Second Great Depression was a confidence killer across the economy, which until that point had held up well.
This was a crisis in bank liquidity, the consequences of another financial bubble like those described in A Random Walk Down Wall Street, now in its 9th edition. This has all happened before although few were as severe as this financial panic. Malkiel points out that many of these bubbles have been inflated by the supposed invention of “new technology” like the conglomerates on the 1960s and the LBOs of the 80s. This time we had astrophysicists inventing new derivatives that not even they understood.
A rational, not political, approach would also have latched on early to the striking fact that much of the subprime crisis stemmed from just a handful of fast-growing counties in four states where housing prices zoomed then plummeted.
Looking back, the biggest mistake was the original Troubled Asset Relief Program — not the idea itself, but because it required Congress’s participation. Giant appropriated sums were never necessary, except perhaps by the screwy reasoning that banks had to be made to lend again for anti-recession purposes.
The Fed and FDIC, formally or informally, had already guaranteed the deposits and other liabilities of the banks. Bank runs were off the table, so even if banks were technically insolvent, they could stay in business and have an opportunity to earn their way out of trouble. Withdrawal of investor support for the securitization of credit-card loans, auto loans and jumbo mortgages does present a big and somewhat related challenge (one the Fed is addressing), but otherwise the economy is not being starved for bank credit.
Jenkins points out that lending is not really the problem; it is demand.
the National Federation of Independent Business, the authoritative small business trade group, has reported deepening pessimism among its members — and yet no credit crunch. “Fewer loans are being made, but a substantial share of the decline is due to lower demand, not problems on the supply side,” the group reported along with its just-released January survey.
As this dynamic has developed, Obama and his assistants have continued to talk down the economy threatening a “depression” unless his pork-barrel spending bill was approved. The result has been the drying up of demand. Roosevelt punished businessmen with confiscatory taxes and changing regulations that paralyzed investing. The 1930s were a time of “capital strike.” Something similar could occur as huge amounts of money sits on the sidelines waiting to see if investing will become attractive again.
The ratio of cash on hand to U.S. market capitalization jumped 86 percent in the first 11 months of the year, the biggest increase since the Fed began keeping records in 1959, as the U.S., Europe and Japan fell into the first simultaneous recessions since World War II.
What will make the owners of this money decide to invest ? I don’t think the stimulus bill is the thing. Nor is a campaign to cancel contracts entered into freely and voluntarily. The present campaign to renegotiate mortgages in bankruptcy court is a terrible idea. Those of us who are current in our mortgages do not seem to be Obama’s favorites. The results of previous attempts at mortgage renegotiation have not done well with a 36% delinquency rate at 3 months and 60% at 8 months.
The crisis has become a political football and those rarely result in good outcomes.
Tony Blankley has some related thoughts on Obama’s governing style.