The Financial Sky Is Not Falling (Yet)

A great post (in English) from mixed English/Italian blog noisefromAmerika with David K. Levine e Michele Boldrin explaining why it does not look like the world financial system is going to collapse tomorrow.

Unless the Bernanke&Paulson couple is not telling the whole truth…

That would also explain the otherwise absurd sight of politicians declaring an upcoming Armageddon with one hand, and squabbling for petty gains on the other.

As usual, the only thing to fear is fear itself (and a rushed-up solution). At this rate, the best thing that can happen is that nothing substantive is agreed until after the Presidential Elections. It’s only a month to go. If President Bush is really worried about it all, he can always impose a one-month bank-holiday period 😉

Most academic economists – the economists who do not work for companies likely to benefit from the bailout, nor for the President – are opposed to this plan […]

the total value of outstanding mortgages is $11 trillion […] while the value of insurance contracts written on them is about five times as large. Clearly, Mortgage Backed Securities (MBSs), CDOs and so on, were used as collateral for lots of additional borrowing […] That explains why, as the value of those houses is dropping the whole castle of cards threatens to crumble. […]

The problem in banking is the possibility of cascading failures, that the failure of bad banks may drag down the good banks […]

What is the solution? One is for the government to step in and buy securities, as proposed in the bailout plan before Congress.

[If those securities are not properly valued, the government] will only get securities worth less than that with the taxholder responsible for the difference. Notice that the ones who reap the rewards are the holders of bad securities […] In effect in order to keep the bad banks from driving out the good we rescue the bad banks.

There are many alternative schemes to the one proposed by Treasury:

  • Require banks to raise more capital. [In that case] the losses are borne by the good banks rather than the taxpayer
  • Forgive debt in exchange for equity. [It is well known that] debt forgiveness schemes have worked for resolving financial crises in the past.
  • Buy foreclosed houses for the value of the mortgage
  • Force an orderly winding down of the housing based derivative market […]

Yes: there can be cascading bank failures and that is a bad thing. But it does not happen instantly, not tomorrow, not next week, not next month […]

The bottom line, in the immediate future, is this. The Federal Reserve Bank and its sister agencies […] already have strong tools against a cascading failure of the banking system. […] We have not seen good banks fail, nor have we seen cascading failures. We have been given no reason to think anything of the sort is imminent. […]

To debunk the obvious: Washington Mutual failed Thursday night. Washington Mutual ATM cards continue to function as usual. […] The fact that banks are reluctant to lend to each other does not have much impact on their ability to make short term loans to customers. […]

If the Federal Reserve Bank and Treasury in fact have information that things are worse than Bernanke reported they should tell us what it is. Otherwise they should stand up and make it clear that doomsday is not around the corner.