Sep. 19, 2008

Finally Paulson and Bernanke Did the Right Thing

Paulson and Bernanke finally moved to restore investor confidence by effectively underwriting or buying many of the bad loans that had been undermining the health of financial institutions in the US. The financial markets worldwide cheered with close to 10% jump in two days.

This behavior of the financial markets once again confirmed the importance of confidence. When confidence comes back, firms that otherwise would fail are saved. When confidence collapses, firms that otherwise were healthy could fail.

I had lamented Paulson's failure to act as a guarantor to facilitate the takeover of Lehman Brothers by potential buyers because that really rocked the financial market and triggered a "tsunami" across the world's financial markets. If this time around Paulson and Bernanke failed to act promptly, it is entirely possible that the US and the world slip into the second Great Depression.

For now the world is saved. I am sure despite the cost in terms of direct taxpayers' money, taxpayers will thank Paulson and Bernanke for what they did.

I hope, though, that they will still take necessary action against real moral hazard: i.e., whose who win big if their bets are right and have little to lose if their bets are wrong. If they are sincere about guarding moral hazard they should be after the decision makers who created the mess, and not the innocent savers both in the US and in the rest of the world.

2 comments:

Anonymous said...

Hi Professor Ho,
I am your student and I have some queries about the recent happening in USA as well as Mr Paulson.
First , said the news today that some of the gov Senators protest the 700bn bail-out proposal from Paulson and raise that it is a waste of the property of taxers so well as an unrational move, what will happen if the proposal is eventually not approved,(as I am not quite sure about the situation in US GOV,the voice from the senator may also has little influence to the final decision) I mean that the government is deemed not that tied together towards the TSUNAMI and it will be another threaten to the fragile confidence, one evidence is that the 3 prime index droped on 9-22 .

Second ,as mentioned from you that Paulson made a big mistake that GOV should help Lehman bro in order to avoid confidence/index collapes ,do you think the consecutive takenover of AIG and the transformation of Morgan stanly and Goldman sach are evitable ,at least to some degree, if Lehman avoided from bankrupcy.

Third ,do you believe the Tsnami will bring destructively big wave to Chinese economy ? Do you think the inflation will be still a keyword in china in future quarters,as predictable that more and more dollars will be printed for the rescue of the recession and it will raise the value of YUAN up,on the other hand, Chinese GOV try to pull down the interest rate for lower the YUAN, seeming that it will become a dilemma.at least to some dereeat least to some degree.

Lok Sang Ho said...

There will always be skeptics. My judgment is that at this time investor confidence is extremely fragile. This means that a collapse in confidence is possible, with dire consequences. It is a collapse of confidence that eventually led to the Great Depression. I thought we have learnt to act more wisely.

It must be noted that extreme risk aversion will undermine asset values. This means that a confidence crisis can actually bankrupt many otherwise healthy firms. Remember a confidence crisis will deflate asset values but will never deflate debt. This means that illiquid firms may suddenly find themselves insolvent.

I think inflation is heading down in China. When the economy is troubled and weak I am not worried lower interest rates triggering inflation. If people are not spending, a deflation is possible. Why should there be inflation?