Misrepresenting the Financial Crisis

It Is Not Lack of Liquidit, It Is Insolvency and Lack of Trust

Published on MRzine, by Ismael Hossein-zadeh, Oct. 26, 2008.

… The bailout scheme imposed by the United States government misrepresents the ongoing credit crunch as a problem of illiquidity, i.e. lack of cash.  In reality, the problem is a lack of trust due to widespread insolvency in the financial market.  In such an environment of widespread insolvency and lack of trust, owners of cash rush to safety: buying treasury bills, investing abroad, or hoarding their cash, thus creating something akin to a black hole for cash – a “liquidity trap” – as explained by John Maynard Keynes.

The “lack-of-cash” premise has been successfully promoted to justify extraction of more than a trillion dollars of taxpayers’ money in the vain hope that it will free the banks from “troubled assets” and create liquidity in the financial markets, thereby triggering a much-needed wave of lending, borrowing, and expansion.

The fact that we now have a perfect case of a liquidity trap is explained (among others) by Professor Peter Morici of the University of Maryland: …

… So, the undisclosed, tightly-kept-secret mountains of toxic assets simply cannot be bailed out.  Not only will the efforts to do so fail, they are also bound to drain public finance, accumulate national debt, weaken national currency, and prolong an economic crisis.

By contrast, the homeowner-centered alternative would have a number of advantages.  First, and foremost, it would help citizens facing the specter of homelessness stay in their homes by allowing them to pay affordable mortgage installments based on reduced or realistic home prices.

Not only will this method of asset evaluation (called mark-to-market assessment) rescue the vulnerable homeowners, it will also cost taxpayers much less money than bailing out the enormous amounts of the Wall Street gamblers’ phony assets.

Furthermore, this solution would also allow the government to gradually recover the market-based home prices it would be paying the failed commercial mortgage holders in order to replace them as the new mortgage holder.

By cleansing the market of the dead weight of tons of junk assets, and allowing threatened homeowners to pay affordable mortgage installments, this bottom-up solution would also help restore faith and trust in the financial system and the credit market — thereby also mitigating the liquidity crisis. (full long text).

(Ismael Hossein-zadeh, author of the recently published The Political Economy of U.S. Militarism, teaches economics at Drake University, Des Moines, Iowa).

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