Repairing a Broken Financial World

The must-read article from the weekend is Michael Lewis and David Einhorn’s two-parter (here and here) in the New York Times. For the most part, I think they describe the problems fairly well. My issue is that I’m not entirely satisfied when a highly complex issue is reduced to the long-term good being sacrificed for short-term gain. Whenever I hear problems put in a neat package like that, I’m suspicious. It’s like hearing that a problem is due to “a lack of communication.” Call me skeptical. The more I look at the credit mess, the more bewildering I find it.

For proposed solutions, Lewis and Einhorn have some good ideas and some not-so-good ideas. For example, when firms get into trouble, let them fail. However, they don’t go all they way and instead suggest nationalizing a failed firm. Well, that’s not letting it fail. When I think of letting a company fail, I mean the real thing. I think the supposed “chaos of bankruptcy” is overrated. Going into bankruptcy protection is a very well-defined area of our legal system. Airlines can exist for a long time in Chapter fill-in-the-blank.

The question I have is can the FDIC come up with a way to protect counter-party risk in a failed firm ala deposit insurance. Plus, an off-with-their-head strategy, as Lewis and Einhorn propose, could cause even more mischief from execs who have nothing left to lose.

Lewis and Einhorn also suggest regulating credit-default swaps but they’re a little thin on the details. More specifically, there are no details.

They also propose breaking up “any institution that becomes too big to fail.” Hmmm. Again, that’s a lot easier said than done. Particularly when you consider that firms often (though not always) become large through success. Therefore the government has to effectively punish success. I have some issues with that.

Comments

[wojmax:]

Your last para* does not make sense. There has been no success. You, the business, lost. Therefore, you get spanked by the feds and placed in the penalty box. Entities will be capped!

* They also propose breaking up “any institution that becomes too big to fail.” Hmmm. Again, that’s a lot easier said than done. Particularly when you consider that firms often (though not always) become large through success. Therefore the government has to effectively punish success. I have some issues with that.

Jan 05 11:09 AM

[axelrod608:]

>> "can the FDIC come up with a way to protect counter-party risk" >>

Sure. It's called INSURANCE and it is regulated and requires sufficient dedicated funds. The reason why the scofflaw financial institutions moved to CDS's was the lack of regulation and capital requirements to back up their bets.

Counter-party risk cannot be protected without financial backing. Outlaw CDS's or require regulation and financial guarantees.

Jan 05 02:30 PM