Wednesday, December 12, 2007
The First Horseman of the Macropocalypse
OK. This is an important post. I strongly suggest, if you're interested in what's gonna happen next, that you block out some time to read, think, and reflect (if you haven't already done so today).
What the Fed has just done - allying with other major central banks to inject liquidity into the banking system without regard for the underlying problems of adverse selection and moral hazard - is nothing short of economic madness.
It's essentially letting the Street off the hook for a decade of malfeasance, transferring risk from the wealthy to the poor, and, ultimately, sowing the seeds of the destruction of the American - and perhaps global - financial engine.
Remember - it's exactly this refusal to deal with basic financial malfeasance that ripped Japan's economy to shreds; which put Japan into an economic purgatory that lasts to this day; one which resists all efforts to shake or break it - because the underlying problems of bad loans and worse DNA still haven't been addressed. The risk and costs have just been swept under the carpet.
I'm not trying to be an alarmist, but the hammer of the macropocalypse is about to fall - the confluence of factors driving the global economic system to a point of irreversible crisis is almost too great to be believed.
Let me put it more simply: The Fed is treating this like it's a liquidity crisis. But it's not: the macropocalypse is a deeper problem. Liquidity is drying because the firm is rotting from the very core: the larger economic system is rife with adverse selection, moral hazard, and assorted other flavours of evil.
I pointed it out for media a long time ago (ie, my new econ of music paper). But it's just as true for banks. So throwing liquidity at rotten institution is perverse because it destroys the incentives for reform.
Imagine if we threw money at record labels, in the hopes that they'd publish better music. What do you think would happen?
Unfortunately, that's exactly what the Fed's doing with the financial system. But
throwing liquidity into a rotten system is just giving the virus new stuff to infect, consume, and decay.
What can we say, in addition a screwed monetary policy, we are engaging in a in a wholesale run on the product development bank, ie, more cloned social networks, more video sharing sites. Each one a clone, each one reaping 5-10 million in capital.
I have to give it to you...this is a very important post...you couldn't be more right on this one!! I have spent the last two days listening to the audiobook of Greenspan's biography thinking deeply about the Fed and its ability to control events in the financial markets....they can't when things are on this scale...they can only pretend!! And that is what they are doing right now in response to a problem that started in the US but has been widely exported...the subprime mess is the tip of the iceberg. There is a massive global house of cards that has been built through the use of unregulated derivative contracts, swaps and many other instruments that no one can see or tally...the subprime thing is just a young sibling to these other instruments or the icing on the cake made up of your "adverse selection, moral hazard, and assorted other flavours of evil".
I wish you were wrong...but you aren't.
A great read on the topic.