When I hear people dismiss criticism of the current bailout efforts by saying that we are in uncharted territory, and that we have to do something, so it might as well be this, it drives my crazy.
Sure, I don't have a Ph.D. in Economics, but does that disqualify me from thinking that the government is incompetent at running the DMV, let alone being in charge of parts of our banking system? That they are bailing out banks and bankers that should be allowed to fail, instead of stabalizing the credit system itself? That devaluing the dollar and propping up home prices are bad ideas? That without transparency at all levels, this mess will drag on for FAR longer than need be? That giving the Treasury a blank check without a solid plan is a recipe for disaster?
Well, fine. I don't know jack. So on this one, I'll defer to Anna Schartz, interviewed this week in the Wall Street Journal. Who is she? From the interview:
Most people now living have never seen a credit crunch like the one we are currently enduring. Ms. Schwartz, 92 years old, is one of the exceptions. She's not only
old enough to remember the period from 1929 to 1933, she may know more
about monetary history and banking than anyone alive. She co-authored,
with Milton Friedman, "A Monetary History of the United States" (1963).
It's the definitive account of how misguided monetary policy turned the
stock-market crash of 1929 into the Great Depression.
And she thinks that the Feds are getting it wrong.
Federal Reserve Chairman Ben Bernanke has called the 888-page
"Monetary History" "the leading and most persuasive explanation of the
worst economic disaster in American history." Ms. Schwartz thinks that
our central bankers and our Treasury Department are getting it wrong
again.
To understand why, one first has to understand the nature of the
current "credit market disturbance," as Ms. Schwartz delicately calls
it. We now hear almost every day that banks will not lend to each
other, or will do so only at punitive interest rates. Credit spreads --
the difference between what it costs the government to borrow and what
private-sector borrowers must pay -- are at historic highs.
This is not due to a lack of money available to lend, Ms. Schwartz
says, but to a lack of faith in the ability of borrowers to repay their
debts. "The Fed," she argues, "has gone about as if the problem is a
shortage of liquidity. That is not the basic problem. The basic problem
for the markets is that [uncertainty] that the balance sheets of
financial firms are credible."
So even though the Fed has flooded the credit markets with cash,
spreads haven't budged because banks don't know who is still solvent
and who is not. This uncertainty, says Ms. Schwartz, is "the basic
problem in the credit market. Lending freezes up when lenders are
uncertain that would-be borrowers have the resources to repay them. So
to assume that the whole problem is inadequate liquidity bypasses the
real issue."
So, to recap, liquidity is not the issue. Trust is. And bailing out the criminals is not the way to solve this problem. Anna continues:
Ms. Schwartz won't say so, but this [the inability to properly price these toxic assets] is the dirty little secret that led
Secretary Paulson to shift from buying bank assets to recapitalizing
them directly, as the Treasury did this week. But in doing so, he's
shifted from trying to save the banking system to trying to save banks.
These are not, Ms. Schwartz argues, the same thing. In fact, by keeping
otherwise insolvent banks afloat, the Federal Reserve and the Treasury
have actually prolonged the crisis. "They should not be recapitalizing
firms that should be shut down."
Rather, "firms that made wrong decisions should fail," she says
bluntly. "You shouldn't rescue them. And once that's established as a
principle, I think the market recognizes that it makes sense.
Everything works much better when wrong decisions are punished and good
decisions make you rich." The trouble is, "that's not the way the world
has been going in recent years."
Instead, we've been hearing for most of the past year about
"systemic risk" -- the notion that allowing one firm to fail will cause
a cascade that will take down otherwise healthy companies in its wake.
Ms. Schwartz doesn't buy it. "It's very easy when you're a market
participant," she notes with a smile, "to claim that you shouldn't shut
down a firm that's in really bad straits because everybody else who has
lent to it will be injured. Well, if they lent to a firm that they knew
was pretty rocky, that's their responsibility. And if they have to be
denied repayment of their loans, well, they wished it on themselves.
The [government] doesn't have to save them, just as it didn't save the
stockholders and the employees of Bear Stearns. Why should they be
worried about the creditors? Creditors are no more worthy of being
rescued than ordinary people, who are really innocent of what's been
going on."
It takes real guts to let a large, powerful institution go down. But
the alternative -- the current credit freeze -- is worse, Ms. Schwartz
argues.
She also puts the proper blame on Alan Greenspan.
"Now, Alan Greenspan has issued an epilogue to his memoir, 'Time of
Turbulence,' and it's about what's going on in the credit market," Ms.
Schwartz says. "And he says, 'Well, it's true that monetary policy was
expansive. But there was nothing that a central bank could do in those
circumstances. The market would have been very much displeased, if the
Fed had tightened and crushed the boom. They would have felt that it
wasn't just the boom in the assets that was being terminated.'" In
other words, Mr. Greenspan "absolves himself. There was no way you
could really terminate the boom because you'd be doing collateral
damage to areas of the economy that you don't really want to damage."
Ms Schwartz adds, gently, "I don't think that that's an adequate
kind of response to those who argue that absent accommodative monetary
policy, you would not have had this asset-price boom." Policies based
on such thinking only lead to a more damaging bust when the mania ends,
as they all do. "In general, it's easier for a central bank to be
accommodative, to be loose, to be promoting conditions that make
everybody feel that things are going well."
So, if it's all the same to you, I'll side with Anna on this one.