Posted by
Philip D. Nathanson on Tuesday, October 14, 2008 10:40:30 PM
The stock market has not run into problems because the government hasn't done enough to support the financial system. It has fallen off a cliff because monetary and fiscal authorities are doing the wrong things. America's two most powerful economic officials, both unelected, Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson, embrace a 21st - century "New Deal," when our problems cry out for economic Darwinism. The Paulson - Bernanke prescriptions are the problem and the stock market knows it.
Its early October plunge was a response to the incendiary warnings by Paulson and Bernanke leading up to the September 29 Congressional vote on the emergency bailout. These officials were spreading panic in order to pass a spending bill.....the $700 billion bailout. Over the next several weeks, the markets responded to the global panic they ignited and the unworkable proposed buyout of some of the banks' toxic assets. (See my Oct. 11 blog for a discussion of how these assets are the root of our problems).
The most effective and efficient solution to the financial crisis is to allow the economic system to adjust. Bernanke and Paulson want to save every badly-run or troubled financial institution. The solution is to let them fail. Going out of business has always been what happens in America when you mess up. And it is a powerful message to others not to repeat the same mistakes in the future. It is also a reward to those who behaved more responsibly, and this aspect is being ignored in discussions. Well-mananged banks will have opportunities to acquire the assets, market share and customers of the failed institutions. They will employ many of the workers of the failed companies, these workers don't just disappear.
The government would have a role, that of easing the transition. It would rescue insured depositors. It would provide short-term collateralized funding to ease the sale or liquidation of the failed institutions. This is already done for failed banks by the FDIC. Officials should tell the weak financial companies to raise capital, allowing the private sector to decide their fates.
But Paulson and Bernanke seem committed to spend us into serious inflation by bailing out every troubled financial institution. Consider the rescue of insurer AIG. What was originally presented as an $85 billion commitment quickly ballooned to $113 billion. Looks like a financial black hole. Far better would have been a bankruptcy reorganization and re-allocation of their businesses to other owners. AIG shareholders and some other creditors would have taken the loss, but no doubt they would certainly be more careful in the future.
The stock market rallied nearly 1,000 points (Dow Jones) on Monday October 13 on news that Paulson and Bernanke were moving away from their poorly-conceived $700 billion bailout purchase of toxic assets and toward a plan bolstering the capital positions of the stronger banks. This was the first sensible proposal to come out of Washington in some time. It would have helped them weather the crisis. Unfortunately, on Tuesday the actual plan presented was one geared toward helping the weakest financial firms. Even worse, the stronger ones were arm-twisted into participating to avoid stigmatizing the weak. When this plan was correctly percieved by investors as a continuation of the bailout strategy, the stock market stalled.
In an opinion piece in the October 14 Wall Street Journal, Fed Chairman Ben Bernanke wrote, " the root of the problem is a loss of confidence by investors in the strength of key financial institutions and markets." This isn't quite correct. The root problem is a loss of confidence by investors in the remedies of Bernanke and Paulson. They don't want any companies to fail. Theirs is an extremely-costly policy and it won't work. The markets know it.