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"Firms that Made Wrong Decisions Should Fail"


SchwartzAnnaDrawing.jpg







Anna J. Schwartz.

Source of image: online version of the WSJ article quoted and cited below.


(p. A11) Most people now living have never seen a credit crunch like the one we are currently enduring. Ms. Schwartz, 92 years old, is one of the exceptions. She's not only old enough to remember the period from 1929 to 1933, she may know more about monetary history and banking than anyone alive. She co-authored, with Milton Friedman, "A Monetary History of the United States" (1963). It's the definitive account of how misguided monetary policy turned the stock-market crash of 1929 into the Great Depression.

. . .

These are not, Ms. Schwartz argues, the same thing. In fact, by keeping otherwise insolvent banks afloat, the Federal Reserve and the Treasury have actually prolonged the crisis. "They should not be recapitalizing firms that should be shut down."

Rather, "firms that made wrong decisions should fail," she says bluntly. "You shouldn't rescue them. And once that's established as a principle, I think the market recognizes that it makes sense. Everything works much better when wrong decisions are punished and good decisions make you rich." The trouble is, "that's not the way the world has been going in recent years."

Instead, we've been hearing for most of the past year about "systemic risk" -- the notion that allowing one firm to fail will cause a cascade that will take down otherwise healthy companies in its wake.

Ms. Schwartz doesn't buy it. "It's very easy when you're a market participant," she notes with a smile, "to claim that you shouldn't shut down a firm that's in really bad straits because everybody else who has lent to it will be injured. Well, if they lent to a firm that they knew was pretty rocky, that's their responsibility. And if they have to be denied repayment of their loans, well, they wished it on themselves. The [government] doesn't have to save them, just as it didn't save the stockholders and the employees of Bear Stearns. Why should they be worried about the creditors? Creditors are no more worthy of being rescued than ordinary people, who are really innocent of what's been going on."



For the full story, see:

BRIAN M. CARNEY. "OPINION: THE WEEKEND INTERVIEW with Anna Schwartz; Bernanke Is Fighting the Last War." The Wall Street Journal (Weds., OCTOBER 18, 2008): A10.

(Note: ellipsis added.)




Comments

While certainly not an expert on the current crisis, I tend to agree with Ms. Schwartz. Having read John Taylor's "Off Track" book, I was disappointed with what I took as the conclusion of Taylor: government intervention was ok, but instead of focusing on liquidity, gov't should've done something to relieve the banks of their bad assets. As an earlier post argued, risk is supposed to mean something, and in this case sub-prime lending meant a greater risk of non-payment. The focus should be on why those loans were made and why the banks that made them (or bought the asset backed securities they were rolled into) shouldn't have to eat the losses (the risk). Ms. Schwartz addresses what seems to be the main argument for not making them eat it: industry collapse. In fairness, there are plenty of commentators on the cause of bad lending practices and perhaps the book's purpose was not to address the causes of the current frozen credit market, but to come up with cures, and between liquidity and counterparty risk, Taylor persuasively argues it was the latter that was the problem and in need of "fixing" if the government insisted on doing something. I would argue, however, that even if gov't doing something to ease counterparty risk opened up the credit markets today, the cost to taxpayers (and the resulting depressant on future economic growth that necessarily follows) and the lesson market participants would learn from the intervention would outweigh any short term benefit. Having finished the book last night, the last paragraph irked me and I figured this was a good place to vent, except I maybe should've waited for Prof. Diamond's official comment before bringing the book up. So my apologies for commenting before you.

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