osewalrus (osewalrus) wrote,

I rarely disagree with Krugman . . .

But I think he has analyzed the central problem of the bailout wrong. Or, at least, has backward what they are trying to solve.

Krugman reduces the problem back to its fundamental -- mortgage backed securities (MBS) have left the market undercapitalized. He therefore concludes that only by replacing the value of the MBS in the market can the market be effectively recapitalized.

But I don't think that's correct. Most money is fictional anyhow. The problem is that people no longer believe the illusion. As a result, they want their real money now. This is what is sending down the value of assets and getting capital to flee from the market.

As I understand what Paulson is trying to do, it is essentially a precision strike to free the blockage from lending institutions. It is not about replacing capital in the market. That is impossible even for the feds. It is about freeing certain classes of institution from the bad debt that is weighing them down so they can make rational commercial loans again.

That requires a lot less capital than recapitalizing the entire market. It means recapitalizing some lending institutions so that they can get the flow of capital running again, while providing enough pixie dust to keep everyone believing the mass illusion that the financial system is capable of lending 10 different people the same $5. Because if everyone believes it, then the capital no longer flees.

Not sure it will work, but it is the only alternative to trying to recapitalize the entire market, which is impossible.

For myself, I am mopre concerned with what happens to these debt instruments and securities when the uptick happens. This is where the nasty game of inside lobbying will make a very few rich at the expense of the rest of us. Once the storm is whethered and the market begins to turn around, we will see some fast talking kind hearted insiders ready to take those "worthless" securities off the hands of the government in exchange for magic beans.

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