Monday, October 20, 2008

Time to take the medicine

Overall, I’ve found the investment and economic analysis of the financial crisis more intelligent than anything in the regular newspapers or among politicians.

One key point — made over and over again — is that the checks and balances are way out of whack. This was evident again this morning, in a Forbes discussion roundtable, featuring Barry Ritholtz of FusionIQ:

Ritholtz: I've written a book called Bailout Nation. Half of it is the study of unintentional consequences. Look at LTCM [Long-Term Capital Management] rescue. The power of the Fed bringing all these bankers into the room and knocking heads together--that's long been considered the good bailout.

But look at consequences, you had a hedge fund under-capitalized, over-leveraged and trading hard-to-sell paper. It went under. Does that sound familiar? If we had taken the hit and let everybody take their portion of the hit then maybe things would have played differently later on. The thing that cracks me up is how completely and totally parallel this is. LTCM take II.
The consequences of taking risks should be that sometimes you lose. Using government money to save risk-takers is a twofold mistakes. If losers get made good on their risks — think Fannie, Freddie and the politicians and banks that enabled them — then next time the speculators will be even more risky.

And then there’s the problem of OPM (Other People’s Money). If politicians freely hand out tax dollars to “save” the economy or “protect the little guy” — paid for by inflating the currency — then there’s no natural limit as to when they will stop, so the problem gets even worse.

To me, this suggests a major shift in our antitrust policies. Many of the bailouts (e.g., of the GSEs and risk-seeking investment banks) have been justified on the basis of “too big to fail.” That suggests that the government should not approve any acquisition that increases the size of a firm that is “too big to fail,” and when (not if) they do fail, the carcass of the rotten company should be dismembered and sold in parts.

The Forbes editors provided the subhead “A Recession Might Not Be So Bad,” which is not exactly what the analysts said, but certainly consistent with general macroeconomic principles. It’s impossible to stop the business cycle and pure conceit (whether by bankers, economists or politicians) to think that you can. The goal should be to use the recession to fix problems, shed inefficiencies, get the US economy ready for its next growth spurt.

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