Wednesday, January 21, 2009

Method to the Madness

Although the government's response to the financial crisis may look haphazard, I just heard a talk by one of the outgoing Bush administration economists who said that the administration's response to the financial crisis is following the Swedish government's response to its credit bubble in early 1992. The Swedes took three steps to address their financial crisis:
  1. Guarantee transactions between banks;
  2. Inject capital into banks; and
  3. Separate the good from the bad banks and let the bad banks fail.
He said that we are 2/3 of the way through the program. But the third part of the task is invariably the hardest. The Swedes had only 6 banks; we have 20,000.

UPDATE: from today's WSJ
There is nothing mysterious about the policy steps that need to be taken to get us out of this mess as quickly as possible. It is not rocket science. In fact, it was successfully carried out by the Scandinavian authorities back in 1991. The banks must be forced to disclose their "toxic" assets (the German banks have about 300 billion euros, the U.K. banks probably 200 billion pounds, and the U.S. banks maybe $800 billion). Then these must be written down to market prices with the hit being taken by shareholders and bondholders -- but not depositors. If that means most banks become insolvent, then so be it.

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