Thursday, September 18, 2008

Let's Backup Quality Firms, not Garbage.

"Look to where you want to go."
"Reward good behavior, not bad."

Those are two axioms I've come to understand that really work in the real world. Applying them to the current financial situation offers some perspective on "what we need to do."

Talk about Moral Hazard
What are we doing now?

By throwing money at the losers the worst of bad behaviors is rewarded. The biggest, most interconnected faulty institutions are getting government assistance.While those that are more prudent and pragmatic are being ignored.

Look at Lehman versus Bear Stearns. Barry Ritzholtz says it best:

• Lehman Brothers was like the little kid pulling the tail of a dog. You know the kid is going to get hurt eventually, and so no one is surprised when the dog turns around and bites the kid. But the kid only hurts himself, so no one really cares that much.

• Bear Stearns is the little pyro -- the kid who was always playing with matches. He could harm not only himself, but burns his own house down, and indeed, he could have burnt down the entire neighborhood. The Fed stepped in not to protect him, but the rest of the block.

Because Lehman was a slightly better market player they and their investors didn't get the benefits of being bailed out, while the Bear, who's executives should potentially be prosecuted does.

Perhaps I'm being naive but wouldn't it be better to break things down, maybe back up smaller better institutions with some sort of government review of investment institutions? (yeah I know this should have been happening all along) It could be followed up with a 6 year guarantee or backing of some sort.

It's not the idea solution or the one that I want. But if you have to intervene in the markets this is better than throwing money at losers right?

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