Of mice and mousetraps

Mice

Mouse on a mission!
Courtesy of bluegreen.blog

Mr. Paulson recalls this foretelling conversation with Ben Bernanke:

“Going back a long time, maybe a year ago, Ben, as a world-class
economist, said to me, ‘When you look at the housing bubble and the
correction, if the price decline was significant enough,’ ” the only
solution might be a large-scale government intervention, Mr. Paulson
said. “He talked about what had happened when there had been other
situations historically.”

Mr. Paulson said he agreed but hoped it
would not come to that. “I knew he was right theoretically,” he said.
“But I also had, and we both did, some hope that, with all the
liquidity out there from investors, that after a certain decline that
we would reach a bottom.”

So, this odd couple, finally decided that holistic sweeping measures needed to be brought to the attention and approved by Congress in order to solve the financial crisis, –the one at a time institution approach was not working.

So, the $1 Trillion question is, are these measures the right ones?

And, going over Paul Krugman’s latest comments, I have to say that I agree with him.

I too believe that every time you give something, you must ask for something in return. It is a totally different story to have the Fed take the toxic waste (CDO’s, credit default swaps, subprime mortgages, and the like) in exchange for billions of USDs as a gift, than to lend with the maximum negotiable collateral available (or achievable) from these companies at this moment.

Paulson and Bernanke have the upper hand, considering only that many of these executives are responsible for carrying highly questionable asset appreciations in their books, and that their companies’ debt ratios should preclude them from continuing their operations.

In other words, the government has to make a little lemonade out of this lemon.

Now, in a deeper sense, is the bailout justified?

I think so. History has proved its case many times, the 30’s depression is our most recent reminder, but, central banks have been around for a few hundred years, and they were created for good reasons.

Let’s start by recognizing that most human endeavor is associated with risks. If we hadn’t taken chances, we wouldn’t be flying, less going to outerspace, nor doing heart surgery, etc, etc.

Then, all activities with associated risk have a down side: failure, which we must expect now and then, due to the laws of probabilities. The important thing to remember, is that this is unavoidable, we may smooth the downturns, but, we do get wet when crossing the river.

Hence, central banks were created to provide the necessary liquidity to avoid depressions, or job destruction, when cycles hit their valley. In essence, this lender of last resort, spreads, atomizing the damage by making us all share the burden of the recovery, which we see as an enlargement of our government’s debt, and at the same time, a weakening of our currency, which in turn, lowers our living standards as our purchases become ever more expensive.

But, the important thing to remember here is that central bank interventions are a hell of a better alternative to the job destruction associated with letting nature take its course, or depressions.

Having settled that the mouse trap is necessary, we know that it may be improved with better regulations, but, we must also acknowledge that the mice will always get the cheese, no matter what. It’s the nature of mice to be ever greedy and insistent, and unfortunately, that the cat has a short span memory, forgets, and lowers the guard.

With these caveats, I agree with Stiglitz proposed measures to (somewhat) correct the problem, and I am particularly fond of creating an agency to oversee and approve the launch of newly created financial instruments –something like the FDA for drugs.

If central banks are always going to be there to take the brunt, they must be very watchful of the new approaches that mice are coming up with to get to the cheese, and to be able to nip the nefarious bud before it spreads and destroys the garden.

This way we could’ve improved the ‘credit default swap’ instrument, or the insurance on credit, in order to have ruled out insurers with insufficient funds to backup the risks they were assuming. As well as detected and corrected the flaw in the paper-work, which allowed distancing the borrower from the lender, in the case of the Freddie and Fannie subprime fiasco.