Sunday, January 18, 2009

Krugman Gets It Right

Yes, Paul Krugman does it.

His analysis of the "bad bank" idea is spot on:

The idea of setting up a “bad bank” or “aggregator bank” to take over the financial system’s troubled assets seems to be gaining steam. So let me go on record as saying that I don’t understand the proposal.

It comes back to the original questions about the TARP. Financial institutions that want to “get bad assets off their balance sheets” can do that any time they like, by writing those assets down to zero — or by selling them at whatever price they can. If we create a new institution to take over those assets, the $700 billion question is, at what price? And I still haven’t seen anything that explains how the price will be determined.

I suspect, though I’m not certain, that policymakers are once more coming around to the view that mortgage-backed securities are being systematically underpriced. But do we really know this? And how are we going to ensure that this doesn’t end up being a huge giveaway to financial firms?
Krugman might deny this, but what he is saying is that the free market is best at pricing assets. In fact, he sounds a lot like his fellow Nobel Laureate Friedrich Hayek. Hmm.

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