Congress passed the Emergency Economic Stabilization Act (EESA), but the markets have hardly stabilized. Don’t the markets know that it is against the law for things not to be stable now that Congress passed a stabilization act?
I think recent events demonstrate that the EESA was completely unhelpful if not counter-productive. But others interpret events as showing that the EESA didn’t go far enough. I’m sure that there are also Marxist academics out there still arguing that full communism has never really been tried because the Soviets didn’t go far enough. And there are education interest groups saying that the doubling in real per pupil spending hasn’t yielded academic improvement because we haven’t spent enough yet. Something didn’t work? Just try more of it!
Well, I came across a very sensible op-ed in the WSJ yesterday that offers an explanation for why the crisis continues and what might be done to really bring about stability. Manuel Hinds suggests that the problem at this point is that financial institutions are refusing to lend to each other. The problem is that some of those institutions won’t repay money that is lent to them because they are truly insolvent, but no one knows for sure who those institutions are. So the safe thing to do is not to lend to any other banks. But this lack of inter-bank lending is having a negative spiral effect. Hinds likens the problem to playing poker with ten people knowing that a few aren’t good for their chips. No one will play until you figure out who can settle at the end of the game.
The solution is to improve transparency so that we all more clearly know who is and who isn’t able to repay money that is lent to them. One of the best ways to gain that transparency is to allow insolvent institutions to go bankrupt so that we know the ones still standing are healthy. Efforts to prop up insolvent institutions just prolong the crisis by disguising who really can repay and who can’t. It would also be essential for transparency to continue mark-to-market accounting, despite calls to do away with it. Without mark-to-market we would have much less information about the value of securities held by financial institutions. More information is the solution and ending mark-to-market subtracts information. There may also be reasonable regulations that would improve the quality of information about financial institutions.
There are real problems in financial institutions but masking them just makes the problem worse.
(edited for typos)
Jay P. Greene's Blog 
I’m not abandoning my comfortable neutrality here, but just to play devil’s advocate: in Wednesday’s Journal, once I had gotten over my binding rage at this, there was this op-ed by Holman Jenkins, who made the comment that “no bank is solvent during a run.”
The other side’s argument is not just that some players will be unable to settle after the game, but no one knows which; their argument is that the uncertainty over which players are able to settle will cause all the players to be unable to settle after the game, since (unlike in a poker game) their actual ability to pay is contingent on others’ confidence in their ability to pay.
I’m not convinced we need to free up interbank lending. Housing mortgages and commerical loans are still being made – for now.
Better transparency is good, but allowing the bad banks to fail plus better transparency is even better. The good banks can survive with what they have, the bad banks will perish (and interbank lending is down but not frozen, I’ve yet to see anything that actually says it is litterally frozen unless they are defining the word frozen to mean less than last year).
And the market is down more than 2000 points since the bailout passed. http://npri.org/blog/bailout-up-market-down
Greg, you’re right that no bank is solvent during a run because no bank has all of the deposits available to be withdrawn. But you can prevent or stem a run by being transparent to current and future lenders (which includes depositors, who are also lenders). This is what George Bailey does in Its A Wonderful Life. He convinces people not to take out all of their deposits by explaining where their money is — in each others’ homes. And because they trust each other to pay it back, he stops the run.
But imagine if George couldn’t explain where the money was because it was in instruments that even he couldn’t understand and no idea how to value. Or imagine he couldn’t explain because the money had already been lost (after all Uncle Billy did lose some of the bank’s money). In that casea run by the depositors might be rational. And efforts to hide the bank’s failure from depositors and other lenders would only prolong the crisis.
The sun still shines. The mass of the Earth remains unchanged. The world’s population has not become suddenly more stupid or ill-informed. But…
Senator McCain’s assertion that the fundamental economy remains healthy missed the mark. What has changed is confidence. Business leaders and political leaders cannot trust each other and we cannot trust them. The proposed remedy, further aggregation of resources and authority, can only aggravate the situation. As the stakes at issue increase, the contest for control will become more intense, and the tactics contestants use will become more desperate and less scrupulous. Confidence will erode further.
Do your part to stimulate the economy; buy a gun.
I once believed that facts and argument could persuade political leaders to change school policy, then I studied the relation between district size and student performance on NAEP 8th grade Reading and Math scores, by State and by parents’ race and level of education. Since the NCES does not make student, school, or district-level performance available to unaffiliated researchers, I use State-level performance statistics and indirect measures of district size: mean district size: the percent of students enrolled in districts over 20,000 enrollment, and the percent of students enrolled in one or another of the nation’s top 130 largest school districts. The coefficient of correlation (%20K+dist., score) is negative for most categories, but is slightly positive for children of college-educated white parents. The State with the highest score, NAEP 9th grade Math (children of college-educated white parents), is (was, when I looked), Washington, DC (NCES includes DC in State-level tables). The State with the lowest score (children of high-school-educated white parents, children of high-school-educated black parents) is (was, when I looked) Hawaii. Aggregation of resources reduces parents’ control. Political control of school harms most the children of the least politically adept parents. Education is related to income and income is related to longevity. Income aside, income is related to longevity, as education aids navigation around life’s hazards. A poor school system is a threat to public health, like a toxic waste dump.
Facts and logic will not persuade politicians; they do not care about the damage they inflict. I’ll believe that our rulers regret the damage they have done when Denny Hastert and Ted Stevens admit that they preferred to use the years 2002-2006, when Republicans had the White House, Congress, and a Supreme Court majority, as an opportunity to cash in, when Barney Frank, Chris Dodd, and Barak Obama admit that they ran interference for the crooks at FNMA and FMAC.
When pigs fly.