Monday, January 10, 2011

Response to Felix Salmon's Muddle-Through Approach

In his blog, Felix Salmon presents the case for the "muddle-through approach" to housing.  It can be summarized as follows:
"There’s something conceptually attractive, especially to small-government libertarians, about ripping the bandage off the patient harshly. Foreclose on anybody who’s delinquent, stop providing massive government subsidies to the mortgage sector and let the market find the true market-clearing level for house prices. But we simply can't do that — it would mean a financial crisis much larger than the last one, with substantially the entire banking system becoming insolvent; the resulting plunge in stock prices and global economic growth could make the last recession look positively tame.
The realistic alternative is to muddle through — to artificially support the housing sector and mortgage valuations for however long it takes, which might well be forever. As Bethany McLean notes, “federal involvement in housing has been a constant since the 1930s” and it’s hard to see any politically-acceptable way of changing that.
Apparently, the argument for muddling-through is based on the fear of a larger financial crisis than the last one.  This argument assumes that the last financial crisis is over.  Current fiscal and monetary policies make that assumption a reach.

There is also the issue of the next financial crisis causing the entire banking system to become insolvent.  How does he know that the banking system is not currently insolvent?  Regular readers of this blog would ask, "where is the asset-level data that shows each of the individual banks in the banking system is currently solvent?"

Finally, the muddle-through approach completely ignores the knock on effects of trying to run a banking system based on suspect collateral values.  Japan has tried this without success for the last two plus decades.

The reason your humble blogger keeps pushing for asset-level data disclosure is that it allows for a discussion to take place based on 'the facts'.  In the absence of 'the facts', it is highly unlikely that we will stumble upon the best solutions.

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