Ben Bernanke Fixes the Crisis

Confidence is not the problem. Bad credits and badly judged loans are the problem...

IS ANYBODY paying attention? asks Dan Denning of the Daily Reckoning Australia. Is anyone listening, or is everyone too busy hoping to care?

What we're talking about are Ben Bernanke's comments. The news headlines read that he predicted the recession will end later this year and the American economy will recover in 2010. But that's not exactly what he said.

Here is what he did in fact say:

"If actions taken by the Administration, the Congress, and the Federal Reserve are successful in restoring some measure of financial stability – and only if that is the case, in my view – there is a reasonable prospect that the current recession will end in 2009 and that 2010 will be a year of recovery."

If you wanted to put it another way, it might go like this:

"If our plan is successful to solve all the problems, then all the problems will have been successfully solved according to the plan."

Juts how inspiring is that? Does it give you confidence that these guys have any idea what they're doing?

What the system needs, of course, is more instability, not less. That is, prices and asset values need to fall to their real level to restore confidence. In this sense, a proper recession is the cure for uncertainty and instability.

Yes, we know this is in direct contradiction to what elected officials are telling you. But think for a moment of a man who's done nothing but eat greasy and fatty foods for a year. He's on his deathbed. His arteries are clogged with fat and cholesterol.

Now, you couldn't improve the man's health by telling him to feel better about himself.

"C'mon big fella. Buck up! Have another cheese burger. With bacon. And avocado. This whole being morbidly obese and killing yourself with fat thing is all in your head. You gotta get your mind right!"

You could tell him all that. But it would be bad medical advice. In the same way, our financial mal-practitioners have mis-diagnosed the economy. Confidence is not the problem. Bad credits and badly judged loans are the problem.

You restore confidence when you directly address the problem. Investors get out of cash and out of gold when they have demonstrable proof that the banks aren't hiding/lying any longer, and that shares or property might offer good value.

Or, as Murray Rothbard puts it in America's Great Depression, "The completion of liquidation removes the uncertainties of impending bankruptcy and ends the borrowers' scramble for cash. A rapid unhampered fall in prices, both in general, and in particularly in goods of higher orders (adjusting to the mal-investments of the boom) will speedily end the realignment processes and remove expectations of further declines."

But instead of realigning with economic reality, our policy makers are acting as if it is possible to sustain all the bad investments made during the credit boom. They want to save homeowners, shareholders, bondholders, and pretty much anyone who stands to lose from the risks gone bad.

That is not possible. Someone has to pay for the bad bets made in subprime loans, Eastern Europe, or the developing world. That someone is probably:

1. the guy who took out the mortgage he can't repay;
2. the bank who made the loan to the guy who took out the mortgage he can't repay;
3. the investor who bought the bond sold by the bank who made the loan to the guy who took out the mortgage he can't repay.

Evading responsibility for one's actions doesn't solve anything. Making other people pay for them doesn't help much either. Of course we're all going to pay for it one way or another, through more bailouts or the general contraction in credit and growth that has to come during the "realignment process".

But those appear to be the two choices: allow failure, which allocates resources from the bad debts and losers to those who can produce real wealth. Or try to "stabilize" any inherently unstable situation, perpetuating over-blown asset values after the credit spigot has been turned off.

Not that we're absolving market institutions for getting us into the problem. The credit ratings agencies essentially sold investment grade ratings on issues they didn't or couldn't understand. AIG sold default insurance on CDOs to make an easy buck. It's now become a black hole for taxpayer capital. But that is fictitious financial capitalism at work, or at waste if you prefer.

The 2002-2007 vintage of financial capitalism is dead, and good riddance. But don't mistake that episode of mismanagement and theft for conclusive proof that "capitalism" has failed. That would be a big mistake.