Regime Uncertainty

9 February 2009 at 4:14 pm 2 comments

| Peter Klein |

Much wisdom in John Taylor’s piece in today’s WSJ. The housing boom and crash were caused primarily by monetary policy and a government-induced relaxation of borrowing standards. Policymakers mistakenly diagnosed the problem as a lack of liquidity and tried to increase loan volume as early as 2007. Further “stimulus” and even lower federal-funds rates came in 2008, followed by a set of arbitrary interventions (selective bank bailouts, the inexplicable TARP). Taylor places special blame on Bernanke and Paulson for creating regime uncertainty:

On Friday, Sept. 19, the Treasury announced a rescue package, though not its size or the details. Over the weekend the package was put together, and on Tuesday, Sept. 23, Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson testified before the Senate Banking Committee. They introduced the Troubled Asset Relief Program (TARP), saying that it would be $700 billion in size. A short draft of legislation was provided, with no mention of oversight and few restrictions on the use of the funds. . . .

The realization by the public that the government’s intervention plan had not been fully thought through, and the official story that the economy was tanking, likely led to the panic seen in the next few weeks. And this was likely amplified by the ad hoc decisions to support some financial institutions and not others and unclear, seemingly fear-based explanations of programs to address the crisis. What was the rationale for intervening with Bear Stearns, then not with Lehman, and then again with AIG? What would guide the operations of the TARP?

I argued before that the whole “credit crunch” may be a kind of self-fulfilling prophecy. Taylor suggests that more generally, the government, having created the crisis, is now deepening and prolonging it by trying to “fix” the problem is made, a classic example of Mises’s theory of interventionism.

Entry filed under: - Klein -, Bailout / Financial Crisis, Public Policy / Political Economy.

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2 Comments Add your own

  • 1. Mike Sykuta  |  11 February 2009 at 9:53 pm

    Last fall I had my management strategy course create the same discounted cash flow valuation pro forma that I’ve required the past several years. This time, it happened to coincide with the market going into a tailspin and lots of discussion about bailouts and such. Because this is an undergraduate course, we use a pretty simple CAPM-type estimation of the working average cost of capital.

    On a whim, we plugged in different market risk premia to reflect increased uncertainty in the market place. I don’t recall the details, but it didn’t take a ridiculously large uncertainty premium to replicate 30% drops in pro forma stock valuations. Nothing about expected cash flows changed, only the rate at which the cash flows were discounted due to uncertainty.

    I hope it was a powerful lesson for the students, especially as they considered (and continue to consider) how the uncertainty created by constantly revised “stimulus proposals” may be reflected in the current stock market.

  • […] Sobre el concepto de “regime uncertainty” en esta crisis: Ver: […]

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