How to save the financial markets

Three problems: 

• "Though Berkshire’s credit is pristine – we are one of only seven AAA corporations in the country – our cost of borrowing is now far higher than competitors with shaky balance sheets but government backing. At the moment, it is much better to be a financial cripple with a government guarantee than a Gibraltar without one. (Buffett)
• "Bond investors worry the government's repeated modifications to its financial-rescue packages are undermining the very foundations of bond investing: the right of creditors to claim their assets first if a borrower defaults. * * * Without more clarity from the government on its bailout plans, the market could continue to drop, say analysts. That would further harm the economy and the institutions the government hopes to help, compounding its task of shoring up the financial system." (WSJ).  Shades of Winstar.
• "Mortgage bonds are also falling in value as the government reworks its plans to bail out homeowners. The new bill, called the Helping Families Save Their Homes in Bankruptcy Act, is intended to stem the tide of home foreclosures and reduce homeowners' debt by allowing bankruptcy judges to alter the terms of mortgage loans. The alterations mean some of the securities tied to those loans will suffer losses, and their ratings could be slashed. Bank of America Securities estimates the bill could affect holders of some $500 billion of mortgage securities who believed they were protected by holding the highest-rated portions of the bonds. Some of these investors are now trying to unload their stakes in order to avoid massive losses or write-downs.(WSJ)

One solution:  The government should simply accept rather than subsidizing financial failure. Guarantees are driving money into bad companies where it doesn't belong long term, and simultaneously driving it away from good companies.  Rewriting contracts roils the financial markets based on these contracts. We already have bankruptcy laws that are designed to sort out the mess and minimize the violence to property rights.  And the government should make this policy very clear right now, and stop lurching around like a drunken elephant.

The result will be short-term pain, but a firmer foundation for recovery in the long term, and those billions in money funds will flow back into the market.  This plan beats the President's wishful thinking about "profits and earnings ratios." 

That wasn't so hard, was it?

Comments

[jack wilson]

I agree that we should let water find its own level. Home prices were too high; they need to come down to their true market price.