21 October 2008

Samuelson's wisdom

What we've discovered is that the real problem is bigger. Large parts of the financial system are too thinly capitalized and too dependent on unreliable short-term debt. Leverage ratios often reached 30 to 1 for investment banks and hedge funds (that is, $30 of debt for every $1 of capital). The presumption was that the MBA types had learned how to "manage risk." That false conceit backfired. Low capital didn't adequately protect against losses. Confidence and trust evaporated, because no one knew which institutions held suspect securities, how much the losses were and who was ultimately safe.

Deleveraging -- a shift from excessive debt toward more capital -- is inevitable and desirable in the long run. The trouble is that, in the short run, it could destabilize the economy if it proceeds too rapidly.

Short hand way of saying that neither of the major-party candidates is likely to get this right.

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