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November 15, 2008

The Problem Isn't Liquidity; It's Uncertainty

Russell Roberts, some economist-guy, explains that Secretary Paulson's "erratic" response to the financial crisis is making it worse:

When no one knows how the rules of the game are going to change — and they seem to change from week to week — who wants to take a risk? Who wants to borrow money? Who wants to invest? Business and consumers are hunkering down, waiting for the storm of change to pass.

The problem isn't liquidity.

It's uncertainty.

Paulson doesn't realize that his erratic attempts at creating liquidity are creating the uncertainty that makes liquidity meaningless.

Paulson's contribution to our woes didn't merely begin when he started switching his proposed solutions every week. It started at least as far back as his panicked trip to Congress. If you thought that Congress might intervene and give you better terms than you’d otherwise get, you might be less willing to lend too, at least until you figured out what Congress is going to do. By serially announcing that it will intervene, Congress has caused lenders to hold their cash more dearly, and thus contributed the very crisis it is claiming to prevent.

More than that, by spreading hysteria that we are on the brink of a second Great Depression, Secretary Paulson, Congress, and the media have encouraged individuals and institutions to hold onto their cash.

However, there is another side to this story. We wouldn't want Paulson to stubbornly continue with unhelpful or counterproductive recovery efforts if an alternative program could do a better job and we expect him to adapt to changing conditions. Unfortunately, Paulson hasn't been giving his proposed solutions a chance to work before switching to new tactics. The Troubled Asset Relief Program hasn't purchased a single troubled asset. As Roberts explains, Paulson will get peoples' hopes up by announcing on one day that he is "exploring" plans to spend TARP funds to prevent foreclosures and days later announcing that won't be possible.

Hey, I know he's got a tough job, but he signed up for it.


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posted by Gabriel Malor at 12:26 PM

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