"The government’s mixed signals about rescuing financial institutions may have added to market turmoil in recent months"

Interesting post on the WSJ :

"The government’s mixed signals about rescuing financial institutions may have added to market turmoil in recent months, a Federal Reserve policy maker said Monday.

In remarks to a conference in Israel, Federal Reserve Bank of Richmond President Jeffrey Lacker said the “disparate” government responses to potential failures at major firms created uncertainty and “may have made it difficult for market participants to forecast whether and in what form official support would be forthcoming for a given counterparty.”

“Shifts in expectations regarding official intervention may have added volatility to financial asset markets that were already roiled by an increasingly uncertain growth outlook,” Mr. Lacker said at a conference at Hebrew University of Jerusalem, according to his prepared text released by the Richmond Fed...

Many investors and Wall Street executives have sharply criticized the U.S. response — spearheaded by Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke — for sending mixed signals during the crisis about which firms might get taxpayer support to prevent their failure. The Fed stepped forward with $30 billion in March to prevent the bankruptcy of Bear Stearns Cos. and facilitate its sale to J.P. Morgan Chase & Co. Six months later in September, however, it declined to offer support to prevent the failure of Lehman Brothers Holdings Inc. Fed officials believe Lehman’s circumstances wouldn’t have allowed for a similar rescue.

The rescue of insurer American International Group Inc. just after Lehman’s failure added to criticism. Now, after Congress passed a $700 billion financial-sector bailout last month, banks are lining up to receive capital infusions from the Treasury."

Here's my comment:

” for sending mixed signals during the crisis about which firms might get taxpayer support to prevent their failure.”

This is the truth. Investors were counting on government intervention in this crisis. Any signal that this might not be forthcoming was seen as a looming disaster.

The government should have acted immediately and decisively, since it had given implicit and explicit guarantees that it would intervene in a crisis. The failure was also one of not having clear policies and guidelines of what would trigger intervention. Consequently, all moral hazard arguments have been fruitless.

In future, we need clear guidelines of government intervention, and moral hazard needs to be clear

Comment by Don the libertarian Democrat - November 3, 2008 at 10:06 am

Lacker does give a positive view of sorts:

“We have to give serious consideration to the idea that this episode of credit and financial market turmoil is part of the economy’s natural response to the sharp decline in the underlying fundamentals in housing finance,” Mr. Lacker said. “My sense is that the deterioration of economic conditions is playing a more prominent role in the tightening of credit terms right now than the direct effects of financial market turbulence.”

But Mr. Lacker said an economic recovery sometime in 2009 is a “reasonable expectation” because the Fed’s interest-rate target has come down to 1%; the major shocks that dampened economic activity — such as high energy prices — are subsiding; and the drag from the housing sector “seems likely to lessen in the next year.”

Call me a cock-eyed optimist, but I agree that we're moving past the crisis stage into the recession stage, and that is actually progress. Also, maybe it's the influence of Casey Mulligan, but I believe that things will begin to improve faster than many think possible.

The long term problems will still be there, but we will have an opportunity to right this ship.