If we were serious about that, we would force banks to write down their loan portfolios aggressively, so that going forward shareholders and managers have nothing to lose by offering principal modifications when doing so would maximize the cash flow value of their loans. But if we did force banks to write their loan portfolios down aggressively, the shareholders and managers with nothing to lose would be different people than the current shareholders and managers of large banks, via some resolution process or restructuring. Which is much of why we didn't do that, when we had the chance, and why bank mismanagement of past loans continues to exert a drag on the real economy as we try and fail to go forward. This very minute, there are homeowners who are nervously hoarding cash, who are leaving factories idle and neighbors unemployed, in order to maximize the option value of the bank franchise to incumbent shareholders, managers, and uninsured creditors.
It looks increasingly as though we're entering Phase 2 of the global crisis, with 2008-9 merely acting as the appetizer. In Phase 1, national and super-national treasuries and central banks managed to come to the rescue and stave off catastrophe. But in doing so, they weakened themselves to the point at which they're unable to rise to the occasion this time round. Our hearts want government to come through and save the economy. But our heads know that it's not going to happen. And that failure, in turn, is only going to further weaken institutional legitimacy across the US and the world. It's a vicious cycle, and I can't see how we’re going to break out of it.
The 'overestimate' of wealth from which we are now suffering occurred first as an exaggeration of value within the core financial system and then as a willingness of institutional investors to take values given by core financial intermediaries as durably sound. 'We' did not decide we were wealthier than we are. Two groups of people whose economic role is precisely to evaluate the quality of our wealth misjudged, one directly by neglecting risk, the other indirectly by trusting the first when it should have known better. The broad public or taxpayers or the polity erred only and precisely by trusting these professionals... 'Mistake' is not a remotely sufficient characterization of what occurred. There were discernible incentives behind the banking sector's misbehavior... We should attend very carefully to the details of how we came to think what we thought, of who told us we were wealthy when we weren't. (Shades of Galbraith...) More importantly, if we cannot evaluate the quality of our wealth going forward, we are unlikely to make decisions conducive to sustaining and expanding that wealth... 'Our' misjudgments were not some random perturbation spiraled out of control. They were the result of a set of arrangements that systematically bribed gatekeepers to make and accept incautious estimates, and to circumvent control systems intended to keep valuations in check. As of this writing, those arrangements remain largely in place.
There are many kinds of looting... The bedrock of an enlightened social contract is, crudely, that rent-seeking is punished, and creating enduring, lasting, shared wealth is rewarded and that those who seek to profit by extraction are chastened rather than lauded... What happens when a nation willfully ignores perhaps the most fundamental lesson of economics, and hopes rent-seeking will equal real prosperity? ... the problems of youth unemployment, underemployment, marginalization, and inequality are so pervasive globally, more and more economists are beginning to point to a lost generation... Our institutions are failing... I call it a Great Splintering — not purely an economic phenomenon... an era when social contracts are being torn up, abrogated, betrayed, abandoned, by accident, by design, by 'regulatory capture,' or simply by polities too gridlocked to progress. Broken social contracts aren't just tidy abstractions, empty of visibly real consequences, disconnected from the noise and clamor of our messy human lives. As they break, yesterday's ways of living, working, and playing rupture; yesterday's organizations, from corporations to banks to nations, creak and crack... For many years now, societies have been limping on with broken institutions and splintered social contracts — right into the heart of this perfect storm. And I'd bet most of us have assumed that we'll continue to 'get by' ... the upheavals we're seeing now are stark evidence that the status quo's faith-based modus operandi hasn't worked — and isn't working.
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