Prisoner shell game

It was widely reported in January that President Obama signed an order to close Guantanamo by the end of the year.

Where will the prisoners go? It was reported in 2008 that a contract was awarded to build a prison complex in Afghanistan, due for completion before the end of the year.

For example, on Aug. 1, the Army Corps of Engineers announced that Prime Projects International, a firm based in Dubai, [UAE], had won a $50 million contract to design and build a prison complex at Bagram to hold 1,000 high- and low-risk detainees. The complex is not expected to be completed before October 2009.

In addition, the Pentagon plans to expand intelligence operations at Bagram, the main prison in Afghanistan.

According to NPR, the number of Guantanamo detainees peaked at 775, a figure well within the capacity of the new prison complex.

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.

Crashing the credit network

It appears that those coping with the credit crisis aren't sufficiently ramped up on network theory. This paper by Zhao et al, titled "Tolerance of scale-free networks against attack-induced cascades", has a paragraph which captures the current situation.

... the presence of such a small set of important nodes means that the network can be fragile because attack on one or a few nodes in this group can have a devastating effect. In particular, considering that those nodes typically handle a substantial fraction of loads necessary for the normal operation of the network, an attack to disable one or few of these nodes means that their loads will be redistributed to other nodes. Because the amount of the redistributed loads can typically be large, this can cause other nodes in the network to fail, if their loads exceed their capacities, which in turn causes more loads to be redistributed, and so on. This cascading process can continue until the network becomes disintegrated. Indeed, simulations show, for instance, that for a realistic power-grid network, attack on a single node can disable more than half of the nodes, essentially shutting down the network...

Lehman Brothers was a well-connected, load-bearing node in a complex network of credit. Its sudden disappearance crashed the credit network. In a disintegrated credit network, no one will lend out money; that condition describes the credit crunch we're experiencing now, where governments and central banks are having to step in as lenders of last resort. Under normal functioning conditions, the loss of a random node won't crash the network. We're not in normal conditions. Calls to "amputate" or otherwise permit major credit nodes to fail apparently reflect a failure to recognize the failure modes that networks can exhibit.

Cascading failure is evident in the commentary on the collapse on a Krugman's blog entry.

What the article really adds, though, is the details of the chain reaction that did the damage... Lehman’s fall led to (1) a run on money market funds, causing commercial paper rates to soar (2) soaring rates on credit default swaps, driving AIG over the edge and sending LIBOR sky-high.