Monday, February 02, 2009

Stiglitz makes a modest proposal

Joseph Stiglitz' proposals got my attention. First, let the banks go bust, then step in:

Mr Stiglitz's radical proposal is a "Chapter 11" scheme for households to allow them to bring their debts under control without having to go into bankruptcy. "Families matter just as much as firms. The US government can borrow at 1% so why can't it lend directly to poor people for mortgages at 4%," he said.

TARP is a bust. Buying preferred shares from banks and expecting them to suddenly start lending again can't work. My reading of the situation is that the credit crunch isn't a dysfunction of the market, but a reflection of markets operating efficiently. Why would a bank rationally risk losing funds on the interbank lending market when there are other banks still yet to collapse? The uncertainty and reluctance to loan is a reflection of real risk. The market is functioning according to the rules of the system, but isn't functioning the way we want it to. Credit is not flowing through the network. Nor is it reasonable to expect that banks can be "bribed" into taking more risk, not after so many were burned by the sub-prime mortgage meltdown.

Stiglitz' proposal to bypass the banks and lend directly to mortgage holders effectively routes around "damage" in the network. It's a novel approach to getting credit where it's needed. If the banks can't do it, create a new mechanism that can.