Yaron Brook from ARI has issued the following statement about credit debacle:
But the mounting financial problems reveal that Paulson and Bernanke are as clueless as any other central planners who try to control an entire economy. They are not saving us from anything; they are delaying some of the pain that necessarily follows from a Fed-induced credit bubble, and redistributing that pain to innocent victims. They are punishing responsible individuals and rewarding irresponsible individuals.
“The bailouts must stop. The government must make clear that from now on, those who are in financial trouble must turn to the private market for help if they are to avoid failure; the government must no longer foist their failures on others, and invite another crisis in the future.”
For better or worse, Brook’s "do-nothing" approach to the problem is not a viable option. Any politician who stood for it would be immediately discredited in the eyes of the electorate. The political reality is that market solutions are not allowed in crisis situations like the one we are facing. Hence we find former Objectivist Alan Greenspan (who understands the underlying political climate better than any of the ARI folks) suggesting another approach. "We need laws that specify and limit the conditions for bailouts -- laws that authorize the Treasury to use taxpayer money to counter systemic financial breakdowns transparently and directly rather than circuitously through the central bank as was done during the blowup of Bear Stearns," Greenspan has written in the paperback version of his autobiography, The Age of Turbulence. In other words, Greenspan is arguing that, since the government is going to intervene anyway (no preventing that), at least it should intervene in as rational a way as possible.
Can the government intervene without making things worse? Well, given how dire the situation really is, it may not really matter. If market forces were allowed to do their thing, the consequences would be little short of catastrophic. There is at least $2 trillion dollars in bad debt out there (and this is not even including bad derivative-related debt, which may be in the tens of trillions). If you allow company A to go under, then it can’t pay it’s obligations to company B. But then company B can’t pay company C, which in turn can’t pay company D, etc. etc. In other words, if the market it allowed to do its thing we would almost certainly see a collapse of a good portion of the financial system. Even more serious, such a collapse could trigger a very serious deflation, as the credit bubble bursts and suddenly you have massive contraction in the money supply (some of this deflation has already occurred, but it has been confined to the housing and asset markets). Deflation is one of the worse things that can happen to an economy in peacetime. If the United States went through a major deflation, that would greatly strengthen the anti-capitalist left in this country, which would put the nation in serious peril (and put an end to any hope for a market solution).
Perhaps the real truth is that nothing can be done one way or the other. Whatever we do, we’re screwed and there’s an end to it. As Doug Noland, the financial analyst who more than ten years ago saw what would happen as a result of wildcat financing of the nineties wrote:
As we are witnessing today, the issue is not some manageable amount of new “capital” to replenish banking system losses. Instead, the predicament is the massive and unmanageable amount of new Credit necessary to, on the one hand, sustain a mal-adjusted Bubble Economy and, on the other, the Trillions more required to accommodate a gigantic speculative de-leveraging. I have a very difficult time seeing a way out of this terrible mess.