Compared To What?

Jim Harper of Cato recommends this excellent article on Reason by Mike Flynn:

Mike Flynn at Reason has a dispassionate - and very readable - piece on the roots of the financial services mess, at which Congress proposes to throw $700 billion in taxpayer funds.

Here's a little from Flynn:

"It is worth noting that immediately after the collapse of Bears Stearns, rumors quickly circulated on the Street of trouble at Lehman Brothers. Lehman went on a PR offensive to beat back those rumors. The company was successful, but then did nothing over the next several months to shore up its balance sheet. Their recent demise was largely their own doing.

The collapse of the MBS market now started to pollute other financial products. (The Fed moves did nothing to deal with the MBS market, but simply provided temporary means to cope with it.) Credit default swaps and derivatives, both of which amount to hedges against the risk of bonds defaulting, came due. Suddenly, stable firms like AIG were overexposed. Insurance companies regularly sell these swaps, as an insurance policy against bonds defaulting. Traditionally they are fairly conservative investment products. These developments threw off the accounting in one division of AIG, threatening the rest of the firm. Given a few days, AIG could have sold enough assets to cover the spread, but iron-clad accounting regulations precluded this. So the government stepped in."

However, the overall effect of Flynn's piece is that both the government and the private market screwed up on an immense scale. It's very depressing to read.

By the way, here's my comment on Reason:

Don the libertarian Democrat | October 1, 2008, 5:11pm | #

It's a very good piece. However, when you say this:

"The one-two punch of Lehman's failure and the government's $85 billion bailout of AIG on September 16 seriously spooked the Street and the Bush administration."

Aren't you admitting that the Street expected a bailout. In other words, the people playing this game all along were counting on a bailout.
If everyone is actually assuming, no matter what they say in public, that they know that the government, whichever party is in power, will not let a crisis like the current one occur without government intervention, shouldn't that figure into our real world expectations.

In the same way, when you say:

"One of the major factors pushing investors into these securities..."

Was someone putting a gun to the heads of these investors? Whatever the government does, are they absolved of stupidity?

The real question is whether or not government will intervene in situations like the current one. Without an answer to that, it is very hard to determine what will actually occur in the real world, or what a rational policy should be.