I’ve been resisting commenting on the financial crisis, wanting to have a better understanding before saying anything. But last night’s debate frustrated me; John McCain let Obama get away with alleging that the problem was a lack of regulation, when in fact it was a combination of government directives and cronyism on the part of Congressional Democrats. Power Line offers a video that does an excellent job of explaining the genesis of the crisis. Virginia Postrel has insightful remarks:
INSOLVENT OR ILLIQUID?
Contrary to widespread popular belief, the “$700 billion bailout” doesn’t involve spending $700 billion, since most subprime mortgages are still OK. They aren’t all going to default. The problem is that once they’ve been sold and chopped up into derivative securities, the good mortgages are hard to identify and untangle from the bad ones. If we knew which were which, we could also separate financial institutions into two categories: those that are truly insolvent and those that are simply in a cash crunch caused by uncertainty and panic.
Good policy should seek to help illiquid firms survive the immediate crunch while forcing the insolvent ones to restructure their debts and essentially (or literally) declare bankruptcy–the sooner, the better. My general inclination is to put policy emphasis on helping healthy firms rather than bailing out losers, including homeowners who can’t make their payments.
She also has ideas about how to address the crisis:
For starters, any lending should follow the wise Allan Meltzer’s Chilean example of requiring firms to cancel their dividends as a condition of any assistance–a proposal that also has the positive effect of generating cash. (Meltzer, one of those people a lot smarter than I am, doesn’t think the government should do anything.)
Second, all assistance should be structured so that it is potentially profitable to the Treasury and–equally important–those profits should be rebated to taxpayers, not thrown into the general federal pot. If, as Andy Kessler suggests, the Treasury stands to make a fortune by becoming a sort of hedge fund, the fund’s “investors” ought to reap the gain directly.
Third, and this will take a while, serious thought needs to be given to creating automatic circuit breakers of various sorts to prevent this sort of contagion in the future.
Last but definitely not least, Fannie and Freddie must go. They not only privatize reward and socialize risk. They do so by design. The whole point of these agencies is to put taxpayers on the hook for mortgage risks that private actors wouldn’t take without them.