Sunday, August 19, 2007

To intervene or to benignly neglect, that is the question

It will purge the rottenness out of the system. High costs of living
and high living will come down. People will work harder, live a moral
life. Values will be adjusted, and enterprising people will pickup the
wrecks from less competent people.

Secretary of the Treasury Andrew Mellon, commenting on the panic of

Wow, that worked out well. I've been hearing a lot of the same sentiment recently, but mostly from the other side of the isle (Mellon was a Republican). The argument goes, why should the government bail out all of these hedge funds for taking on too much risk? While such arguments appeal to my sense of justice, they seem to forget the fact that many more people will be hurt if the Federal Reserve doesn't step up and provide some help.

Quoting Kindleberger in "Manias, Panics and Crashes":

...while it is desirable to purge the system of bubbles and manic
investments there is the risk that a deflationary panic would spread and wipe out sound investments by the non-speculators who would not be able to obtain the credit they need to survive.

All I can say is that I wouldn't want to be in Ben Bernanke's shoes right now.

On a related note, there is one critical advantage that a Fed policy of benign neglect might bring that I think most people have forgotten. It goes nicely with the arguments of Mr. Mellon. With a little pain and suffering comes excellent rock and roll! Just think of it. What was the last band that mattered? We have to go back to the last housing market downturn in the early 90's when grunge took over the world. While there have been some good bands since then, no band has struck a chord with the country's state of mind as did Nirvana. A recession would probably purge the country's obsession with celebrities as well.

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