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September 23, 2008
Some institutions find themselves with too little capital to support lending. Some are also unable to raise the money they need to finance the securities. By selling assets, to raise money, they have depressed prices further. This has weakened balance sheets, forcing them to dump yet more. The plan of Hank Paulson, the US Treasury secretary, is to buy up $700bn of these toxic securities and to put a floor under the price.The aim is to end the spiral and the de-leveraging convulsion.
This cash for trash effectively bails out Wall Street. The libertarians in this financial crisis are hiding in the foxholes since government isn’t seen as the problem in Washington these days, as it’s the solution.
The spiral highlights a real problem. As finance shrinks, credit is being sucked out of the economy and without credit, people cannot buy houses, run businesses or as easily invest in the future.The financial sector needs capital, because assets like houses and promises to pay debts are worth less than most people thought. Even if some gain from falling asset prices, lenders and insurers have to book losses, which leaves them needing money. Governments are the only buyers around.
If bailing out Wall Street's shadow banking system increases the huge US national debt, then it also puts another nail into the body of the US model of free-market capitalism. Morgan Stanley has turned to Asia for a capital lifeline of $9 billion. Morgan Stanley and Goldman Sachs have converted into banks and so will now be regulated as banks. So the shadow banking system continues to unravel.
A question: isn't it it better to boost the banking system by increasing its capital than by reducing its loans?As Paul Krugman points out even if the vicious circle is limited, the financial system will still be crippled by inadequate capital. The financial system needs more capital is the core argument. You can’t socialize the losses if you don’t also socialize some of the gains.
And if the government is going to provide capital to financial firms, it should get what people who provide capital are entitled to – a share in ownership, so that all the gains if the rescue plan works don’t go to the people who made the mess in the first place.
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Krugman has a good line:
Love it.