Sunday, December 18, 2011

A financial crisis needn't be a noose

In her NY Times column, Christina Romer observes that it is how policymakers respond to a financial crisis that dictates its aftermath.  As the editors of the NY Times pithily put it, a financial crisis needn't be a noose.

That a financial crisis needn't be a noose is a point that your humble blogger has been making since the beginning of the solvency crisis in August 2007.

The global policymakers have chosen to turn the financial crisis into a noose with which to strangle their economies.

The moment when these policymakers made this choice is when they decided that banks should not absorb the losses on the financial excesses that they created.

Instead of having banks operate as a safety valve between the financial excesses and the real economy, global policymakers decided to make the real economy bear all of the financial excesses.

The result has been to effectively condemn the global economy to follow Japan's lead and the promise of multiple lost decades.

As your humble blogger has said repeatedly, it is still not too late to change course and put the losses where they belong --- on the banks.

Forcing the banks to write their assets down to a realistic value has many benefits.  Several of which were identified by Fed Chairman Ben Bernanke when he spoke to Japanese officials about how they should handle their solvency crisis.

  • It stops the distortion in pricing of assets that is currently going on - think commercial real estate prices being influenced by extend and pretend.  When asset prices are being distorted, it is very difficult for market participants to make investments.

  • It allows debts to be restructured consistent with the borrower's ability to pay.

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