Left Flank

Left and right, blogs are sighing with relief. Another «new-and-improved» bailout bill is on the way.

Chris Bowers is content the Paulson plan-cum tax breaks and an FDIC proposal, a progressive addition will squeak past the post (although the bar is higher because of the tax provision). The Weekly Standard has another list of possible House inclusions.

The message from the House is clear: sausage-making as usual. Don't reconsider the idea, just amend the bill to entice opponents. I hope there's the shock works, and that there's no need for further injection later.

But, will this bill please angry Independents?

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It's too fitting. A year after the US, the winner of the Cold War, spun into financial meltdown, Russia, its vanguished foe, succumbs to the same malady.

What makes Anders Aslund's essay even more noteworthy is, that, unlike the warmongers among the pundit class and the Pentagon who believe Cold War is resumed, Aslund interprets the August War between Georgia and Russia as the «second act» in an economic debacle begun in the 1990s.

Is Anders Aslund being a bit too dramatic when he predicts a «tragedy in five acts», with three acts yet to run?

The Russian stock market is in free fall, plummeting by 60% since May 19, a loss of $900 billion. And the plunge is accelerating. As a result, Russia's economic growth is likely to fall sharply and suddenly.

(...)

Russia is just about to enter the third act of this tragedy, a banking crisis. Numerous medium-sized banks, and some large ones, are set to go under in the stock-market turmoil. Too many big investors can no longer meet their margin calls, while borrowing costs have risen sharply. The recent appreciation of the dollar adds to their hardship.

I'm placing my marker on this prediction. I do it rarely, but the last time I did, Shinzo Abe's government in Japan fell in less than a year. I hope I'm wrong.

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Eswar Prasad takes the broad perspective of financially-underdeveloped NICs towards the Wall Street meltdown calling for a «principles-based» regulatory framework.

What went wrong in the US? A key problem with Fannie Mae and Freddie Mac, for instance, was that their regulator failed to do its job of uncovering the massive accounting fraud embedded in their books. That and the implicit guarantee of government backing (which finally turned explicit) allowed these two institutions to expand enormously, including into exotic financial transactions that they had no business being involved in.

The roots of the US crisis, of course, go back to the years when Alan Greenspan was chairman of the US Federal Reserve. Then, money was easy and regulation light. The famous ninja (no income, no job and no assets) mortgage loans were as clear a sign of regulatory negligence as any. But these obvious signs of malfeasance were all too easily ignored when times were good and in the face of the current US administration's hostility towards regulation.

Clearly, financial innovation without effective regulation does not work well. In the new world of more sophisticated financial markets, dangers lurk in hidden places.

Today's crisis indicates that a set of rigid rules allows resourceful financial institutions to mask riskiness in their portfolios or shift things around to make standard risk metrics appear better than they really are. It is impractical to devise a regulatory framework that accounts for every specific financial instrument and institution. Rather, it makes more sense to develop a «principles-based» framework that can adapt to financial- market evolution and adopt a broader approach to managing systemic risks. Clearly, that was lacking.

The crisis also confirms that some types of government involvement in financial markets – especially through implicit backing of ostensibly «private» institutions – generate bad outcomes that end up with taxpayers inevitably footing the bill. The real lessons from the Fannie and Freddie debacle should be about the dangers of implicit government guarantees coupled with moral hazard and weak regulation, and the risks that lurk even in advanced financial systems. These risks are greater in less-developed financial systems, and the costs of cleaning up the messes could also be proportionately larger for poorer economies.

One thing the crisis does show is that fraud, corruption, and government interference can eat away at the foundations of even the deepest financial systems, especially when these problems are compounded by a regulatory system that is too narrow and rule-bound in its outlook and that, at times, turns a blind eye to obvious rot in the system. Now that, at least, is a lesson the emerging markets definitely should take away from the financial crisis.

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Russell Roberts fisks Joseph Stiglitz on the financial troubles, and it's well worth a read.

Before I want to convert out of the Friedman/Hayek religion, I want to get the facts. In recent posts, I've focused on facts that fit my worldview. That's because I didn't know much about government's recent involvement in housing markets. It's not the whole story. I'm still thinking things through. But one question we should all be asking is whether the mess we're in is the result of too much government or not enough. I'm in the «too much» camp. Let's look at the other extreme, the «too little» camp and its most illustrious member, Nobel Laureate Joseph Stiglitz.

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Robert Samuelson asks if Henry Paulson has an end game.

It's all about confidence, stupid. Every financial system depends on trust. People have to believe that the institutions they deal with will perform as expected. We are in a crisis because financial managers -- the people who run banks, investment banks, hedge funds -- have lost that trust. Banks recoil from lending to each other; investors retreat. The ultimate horror is a financial panic. Paulson aims to avoid that.

Objections to Paulson's proposal abound. It would rescue some financial institutions from bad decisions. Some investors doubtlessly bought subprime securities at huge discounts and would reap massive profits by reselling to the government. That might trigger an angry public backlash. The program would be huge («hundreds of billions,» says Paulson) and could burden future taxpayers. To which Paulson has one powerful retort: It's better than continued turmoil and possible panic. But that presumes success and begs an unsettling question: if this fails, what -- if anything -- could the government do next?

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