Good Layman's guide to the financial crisis

[Surferbeetle]

Dr. Mankiw, of the Harvard Economics Department, has an interesting blog (and his textbook Macroeconomics is a good read as well...)

I don't pretend to be enough of an expert, or to be close enough to the facts, or to have a large enough staff, to know what should be done with the banking system, which is at the center of our current economic turmoil. But I am confident that fixing it should be the main focus of policy efforts.

In this regard, I found this tidbit thought-provoking:

"The word 'nationalization' scares the hell out of people," Rep. Maxine Waters, D-Calif., said on "This Week." To combat that, some clever advocates of nationalization have come up with alternative names, including "government receivership" and "pre-privatization." (Source.)

The search for alternative names can be amusing at first, but I think there is more here than mere semantics.

From a Wired article by Felix Salmon: Recipe for Disaster: The Formula That Killed Wall Street

For five years, Li's formula, known as a Gaussian copula function, looked like an unambiguously positive breakthrough, a piece of financial technology that allowed hugely complex risks to be modeled with more ease and accuracy than ever before. With his brilliant spark of mathematical legerdemain, Li made it possible for traders to sell vast quantities of new securities, expanding financial markets to unimaginable levels.

His method was adopted by everybody from bond investors and Wall Street banks to ratings agencies and regulators. And it became so deeply entrenched—and was making people so much money—that warnings about its limitations were largely ignored.

Then the model fell apart. Cracks started appearing early on, when financial markets began behaving in ways that users of Li's formula hadn't expected. The cracks became full-fledged canyons in 2008—when ruptures in the financial system's foundation swallowed up trillions of dollars and put the survival of the global banking system in serious peril.

A viewpoint from Asia

The U.S. struggle for bailouts is actually a struggle between two factions. Those who support the bailout believe that the government should be able to iron out the economic cycle and that measures to counteract the cycle can help the overall market get through this crisis. Trust the government, they say. However, people from a different school of thought hate this. They believe that without economic cycles, there would not be a free economy. From the founding of the country until today, the U.S. has been tested countless times by economic cycles. As long as people have faith in the market’s strength, they can tough it out. Although a price must be paid, it is necessary. It is not easy for any single economic structure to achieve a transformation.

The U.S. government is standing at a crossroads. Should it temporarily squash the spirit of the free market in order to let the economy get through the crisis, or should it protect the free market and let the economy suffer the pain? The scariest thought is that even after squashing the free market spirit, it will still suffer pain. Relatively speaking, nationalization is really the riskiest choice.