Blog Post On: 3/25/2009
Paul Krugman (2008 Nobel Prize in Economics) wrote an article titled "Financial Policy Despair" where he details why buying Toxic Assets will not work, and discusses a proven plan that has worked in the past. He goes on to say that the investors that buy the debt can walk away from it. The existing plan seems like a phony way to inflate the value of the toxic assets in the hope that lending will spur consumer spending. This all seems to be built on vapor.
Here is a snippet of what Krugman has to say...
As economic historians can tell you, this is an old story, not that different from dozens of similar crises over the centuries. And there’s a time-honored procedure for dealing with the aftermath of widespread financial failure. It goes like this: the government secures confidence in the system by guaranteeing many (though not necessarily all) bank debts. At the same time, it takes temporary control of truly insolvent banks, in order to clean up their books.
That’s what Sweden did in the early 1990s. It’s also what we ourselves did after the savings and loan debacle of the Reagan years. And there’s no reason we can’t do the same thing now.
But the Obama administration, like the Bush administration, apparently wants an easier way out. The common element to the Paulson and Geithner plans is the insistence that the bad assets on banks’ books are really worth much, much more than anyone is currently willing to pay for them. In fact, their true value is so high that if they were properly priced, banks wouldn’t be in trouble.
But the Geithner scheme would offer a one-way bet: if asset values go up, the investors profit, but if they go down, the investors can walk away from their debt. So this isn’t really about letting markets work. It’s just an indirect, disguised way to subsidize purchases of bad assets. - Paul Krugman
Read the full article here