Monday, September 15, 2008

Finally Throwing Up

Frankly, this has been a disappointing time for global capitalism.  Consumers have made poor decisions, companies have mispriced risk, and investment decisions have not been made on the basis of fundamentals.  The savings that fled emerging markets to Wall Street was justified on the premise that modern finance is correctly regulated and quite efficiently allocates resources through advanced financial engineering.  Clearly these assumptions were not warranted; though keeping money in BRIC stock markets doesn't seem like a great idea either.  

The federal response to the crisis has been troubling as well.  Successive rounds of bailouts and guarantees for companies such as Bear Sterns, Fannie/Freddie, and the Auto manufacturers.  It's hard to criticize any individual action--Bear Sterns' collapse was very rapid, Fannie/Freddie had an implicit government guarantee--but the net effect has involved the government postponing the difficult acts of failure necessary for a properly functioning capitalist system.

The big fear is that the housing market crash and credit crunch will be followed by a decade-long stagnation as happened in Japan.  In some ways, the fundamentals in the US are even worse than those faced by Japan--savings are essentially zero, there is no room for either a fiscal or monetary expansion, the housing boom was financed with low down-payment mortgages, and growth has been anemeic the last decade as it is.  

The economic post-mortem of the Japanese crisis has placed the blame on Japanese policymakers and bankers who enabled delayed writting off bad assets.  Instead of clearing the books, taking the hits, and moving on; the Japanese banking system remained in stasis.  Failure to direct resources to the most productive sections of the economy and keeping zombie loans in the essentially valueless portion of the economy prevented revival.  The American federal response--trying to keep institutions alive as much as possible and feeding Wall Street through guarantees, rate cuts, and liquidity--has echoed Japan's response.  The corporate response, involving poor board governance, opaque balance sheets, and a reluctance to mark assets to market has also been disappointing.

I don't claim to understand even a portion of what's going on, and have little idea of what to do now.  But I'm glad to see Lehman fail.  Finally: A poorly run firm that failed to take its medicine comes begging to Paulson and Bernake, the government says no, and the firm pays the consequences of taking risk.  I don't know if this will seriously deter firms in the future, but it's healthy to see anyway.

This response and the outpouring of blood in the streets makes me very optimistic about the future.  AIG's fall isn't going to be the last, but life will go on.  Also, how nice is Goldman Sachs sitting right now?  They've been profitable the whole way and currently operate in a duopoly.  I await the poorly thought out regulatory responses from Presidential nominees with great interest.

Update: A talking head on CNBC says, "This has been like having food poisoning without throwing up for three weeks, and we finally did."  I wish I thought of that phrasing.    

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