Tuesday, September 16, 2008

Too Big to Fail

Just six days ago, I wrote that John McCain was late giving up manufactured outrage over lipstick and needed to pivot toward a real message on the economy. Unfortunately I suspect that window is shut now. First of all, with all that's happened this week, he appears to be late to the party. Second, what he has said isn't exactly worthy of the brilliancy prize (more on that later).

It's been said of several big teetering financial institutions, Long Term Capital, Fannie and Freddie, Bear Stearns, Lehman Bros. (oops sorry guys), and most recently AIG that they are "too big to fail." This has been repeated enough to be a cliche without necessarily figuring why. Financial institutions have to be able to deal with each other with the understanding that in the vast majority of the time (more often than with other generic businesses), the other party will be able to live up to their obligations. Too big to fail means that a financial institution is so entrenched in its obligations to other firms that if it fails then its counterparties likely will as well. By the time the cascade of failures is finished, there won't be enough solvent institutions remaining to lubricate the wheels of a healthy economy.

The point being, most of the economy lives outside the financial sector, and the crisis inside it needs to be viewed from that point of view. The economy as a whole needs institutions that can store capital on others' behalf, and extend various kinds of credit. Even if the events of this week are resolved well enough, we're still not out of the woods. Just because there's players out there with money who can extend credit, does not at all imply that they will. In the big picture, the crucial factor is growth. In the end, it is growth which generates the credibility that money lent out will eventually be paid back. As it stands right now, things aren't so bad. Growth has been ok, and credit is available for creditworthy parties, even if the liquidity of the secondary debt market has dried up. It's what happens when things turn for the worse from now that we should be afraid of.

Except for the Bush tax cuts, John McCain's record in the Senate is actually pretty good. The problem is, he seems to view the mechanics of the economy as morality play. He's not alone in that of course, but for him it fuels the perception that his life experience is in substantial ways lacking in the ability to engage peoples concerns now. In any case, it's seems to me that the weakness in the Republican ticket is on the top, not the bottom.

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