The last credit show

PHOTO OF THE YEAR: I love this picture, taken at the Capitol Friday, just after the bailout passed.

Pelosi hasn't the slightest clue what just transpired. Hoyer's distracted smile suggests he knows something bad is going down, but he can't put his finger on it. Only Emanuel's glum look indicates someone who gets it.

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I don't know about all those bloggers who post every few hours, but I've virtually run out of things to say about the financial crisis.

I'm not happy with some of the conservative talk radio types denouncing businesses for running on short-term credit as a form of money. Modern business activity couldn't proceed at the level it does, accomplish what it accomplishes, and employ the people it employees, on a cash-only basis. Long ago (in the 19th century, actually), capitalism outgrew the cash-only system, just as it eventually outgrew the gold standard. Businesses, consumers, and governments make extensive use of short-term credit because spending and income don't always match at every instant in time. Short-term credit is a way to shift money flows so that it does all balance out. The Federal Reserve counts cash and cash equivalents as basic forms of money (M1). But short-term credit functions as money as well and gets added to form M2. It walks and quacks like a duck. Thus, it's a duck.

Sometimes it strikes me that certain conservatives, unfettered, would abolish fractional reserve banking and credit-as-money, thinking that they're just some slick phony-baloney. I wonder if they think a modern economy could function that way.

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OTOH it has been impressive to see economists, especially younger ones, publicly denouncing the bailout. Part of the opposition is prompted by the bailout's being embarnacled with "sweeteners"; i.e., bribes to get the Congress-critters to pass it. But the opposition also has an intrinsic economic basis: the government shouldn't be pledging taxpayer money to buy up assets with declining prices, when we don't yet have a good sense of what their real prices are.

Most economists -- excluding economists opposed outright to any rescue -- have pushed "recapitalization": essentially, some way of tiding over lenders, equivalent to my pet proposed series of ad hoc, strings-attached, short-term loans.* But it's vital to decouple steadying the credit markets and falling asset prices, precisely so that the asset shakeout can proceed without threatening the financial system. To reiterate: the credit crunch has to be dealt with first.

The larger tidying up, with its lessons about moral hazard and its punishment of the innocent and rewarding of the guilty, will take a few years. The government shouldn't be in the business of buying up and reselling distressed assets, except as part of larger post-bankruptcy settlements. Once an economic actor is bankrupt, it's out of the game, so to speak, and the risk of open-ended commitments and market distortions is much lower.

POSTSCRIPT: Some of the biggest doomer-gloomers (like our friend Fabius Maximus) have been pushing the "end of the American era" as a result of this crisis. But the dollar's rise belies such talk. Related crises are happening in Europe and Asia, and they are in some ways worse than ours.

That's also why investment banking, as practiced on Wall Street until recently, won't be decamping to London or Hong Kong. It really is dead.
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* I was probably too harsh on Krugman for pushing "recapitalization." It's the right idea, but banks and other lenders will eventually have to do something about the mismatch between falling housing prices and yesteryear's mortgages. The credit crunch can't wait for that resolution.