Thursday, October 9, 2008

Creating a problem to fix

The DOW is down a couple thousand points now *since* the "bailout" was passed. I was thinking about that today when I realized that, at least in the short term, the bailout probably *is* the problem.

I've seen the "bailout" or "rescue plan" called the "splurge", which is probably a better word; so I'll use that - since it accurately describes throwing money at the problem.

One of the ideas of the splurge is these debt auctions which will essentially set a price on the toxic mortgage assets that banks are holding.

The problem is that the splurge isn't going to happen for six weeks or so. Instead of taking an approach that would have allowed the market to work this out on its own, this forces a period of uncertainty until the auction takes place. I think this puts the banks in a holding pattern until that time. Private equity isn't going to come in and price these assets, like they might have if there hadn't been a splurge passed, until they find out where the government is going to price them.

This is with some partial hindsight now. But it explains the fact that other measures haven't worked in the interim (lowering rates, announcing commercial paper buying, etc.).

If this is true, then when the splurge takes place it might improve things simply because it will remove the uncertainty from the credit market that it helped perpetuate. At that point it will be fixing the problem that it helped cause.

So the pro-government-interventionists will be eager to make the point that the splurge worked, when in fact it may just end up undoing the harm that it caused in the intervening weeks (if we're lucky). Only time will tell.

I would have much rather seen a plan that didn't have the government try to fix the problem by becoming an actor in the market, but instead something that put in place incentives to make the mortgage derivative market liquid again. Removing taxes on future capital gains on mortgage derivatives or something of that ilk.

Anyway, as things are, it seems like the splurge itself may have cooked into that things aren't going to get better in the credit markets until the splurge happens.


  1. Of course there is common thought that government intervention, whether through greater regulation or subsidies hurts consumers at the end of it all; the free market should be allowed to shape things.

    Given that premise though, what is your vision of how the country’s energy policy would shape if we allow the free market and consumer choice to determine the fundamentals of the American energy policy? Should I be afraid?

  2. I should dedicate a whole post to it perhaps. The short of it - I think that the "free" in free market has to be defined. Laissez-faire is sometimes used to mean completely unfettered.

    Very broadly, I think what makes sense is to have government set the boundaries and for competition to then control what gets produced in those boundaries.

    What I think is a mistake is government backing specific technologies or companies. For instance, ethanol subsidies are a disaster because they divert food to fuel and drive inflation up. Direct subsidy of Hydrogen economy would also be a problem because there is no proof it works, and it might divert attention from a better solution.

    One or two months back I read an article in Wired (I think that's where) that quoted someone who worked in the solar energy industry for years (decades) who said he thought it was bad when government provided subsidy to that specific technology. What he said happens is when government starts providing subsidies to technology, companies stop innovating and start lobbying to get some of the money. So it really hurts the technology more than helps.

    It seems right to me that government (as representative of the people and their desires) set the rules (basically, what the acceptable "externalities" of the area should be (such as pollution limits)) and then let the market optimize what can be delivered within those constraints.