Monday, October 13, 2008

Global Panics Call for Global Response

What is clear this morning is that the coordinated (and quite dramatic) action of both US and European governments have potentially turned the tide on the global banking panic.  Individual actions were not enough, the finance sectors of each individual economy are so intimately intertwined that confidence can only be restored by coordinated action.  Of course the rally in the worlds exchanges could be short lived and there will still be blood spilled in the banking sector, but for now the outlook is positive.  

This all begs the question (once again): are the world financial markets so enmeshed that a global system of regulation and oversight is needed?

By the way, I am often asked about the strategy of buying equity rather than buying the toxic assets as in the Paulson Plan.  I am generally in favor of this for three reasons: one, the toxic assets are so complicated that figuring out what to pay is very hard - buying equity is simple and can be done quickly; two, buying equity is a direct capital injection that gives the government something tangible in return for its investment; and three, I think it restores confidence more forcefully than the buying of toxic assets.  But I also have hesitations: one, the government, finding itself part owner of failing banks, have a new incentive to prevent them from failing - even when they should; and two, if one is worried about rewarding the fat cats for bad decisions, this does that more directly.  On balance I am tilted pretty far toward the direct equity approach, especially after the terrible response by the market for the Paulson plan.

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