The cause of the crisis

The bailout will fail.

If the government offers implicit or expicit debt guarantees, if a firm is “too big to fail, then that firm can easily borrow lots of money cheaply, and lend that money to people not so guaranteed at a higher interest rate.

Free Money!

The too big to fail firm is going to take absurd risks that no one would ever take with their own money. And if trouble ensues, then they have less to lose, in proportion as the taxpayer has more to lose, so they will bet even bigger.

To prevent this, the government regulates these “too big to fail” entities, prohibiting them from taking excessive risks.

Regulation failed in three ways:

  1. Gaming the rules by financiers: The government felt that judgments of character, competence, and credit worthiness were too subjective, so wanted risk evaluated by the numbers. But you cannot evaluate risk by the numbers! So the numbers were gamed, and loans to reckless people of bad character were rearranged to as to have wonderfully low risk numbers.
  2. Political correctness by government: The government and various interest groups noticed that when borrowers were evaluated by credit worthiness, character, and competence in managing money, most people with good scores were white. So they pressured financiers to abandon these criteria, and regulated them to make loans that required them to abandon these criteria – and since the financiers were too big to fail, they were willing to comply.
  3. Loss of contact with reality by accountants: Accountants, both by natural inclination, and because they were compelled by Sarbannes Oxley regulation, focused on the numbers, forgetting what the numbers actually stood for. When the unreality of the numbers was revealed, the entire financial sector became paralyzed. They are in the dark, and there is no source of light proposed

The bailout is an effort to keep business as usual going – but business as usual was not working, failed, failed catastrophically. We need a new finance sector, a main street finance sector where local bank branches ledn to to local people on the basis of character and solvency. Most of the wall street finance sector which the bailout is intended to keep alive needs to be shut down, to permanently go out of business, and despite massive cash injections, it simply is not in business right now. It remains paralyzed, despite gigantic handouts of cash, because they are aware that if they were to resume business as usual, they would piss away the new money in the same way they pissed away the old money.

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