Financial Crisis: Painkillers Vs. Cures

On Friday the markets fell despite (or in response to) the passage of the bailout bill, today (Monday) we’re experiencing a global sell off,, and domestically the Dow (^DJI) is down by about 4% (at the time I was writing this) and the S & P is down by about 5%.  Meanwhile the credit crunch continues to deepen despite the passage of the bailout bill and the recent moves by the Fed to flood the world with dollars.

Obviously things are continuing to get worse despite the best efforts of the U.S. Government, the Fed and their counterparts around the world, which begs the question: are they merely preventing things from getting worse (mitigating a calamity into mere disaster) , are their actions insufficient with respect to the scope of the problem, are they merely attacking the wrong problem, or is it a combination of all three?

My view is that while their actions are serving to mute things a bit, the real problem is a fundamental problem with the banks operate, their financial structure (use of derivatives to meet capital requirements, credit default swaps as regulatory arbitrage, etc) and the way they’re regulated. Not to mention the fact that the problem is being approach (for the most part) as if it’s merely a crisis of confidence, as opposed to a crisis created by financial institutions that are simply losing money on bad investments, are insolvent (or close), on top of being over leveraged and under capitalized.

While you can’t fix a broken system overnight, pumping money into a broken system in order to prop it up until “things get better ” isn’t exactly a good idea either. It’s somewhat analogous to just giving Advil to a patient with a broken leg, instead of giving them Advil, setting their leg and making future arrangements for physical therapy once the leg heals.

In other words the problem with the current round of solutions is that the governments and central banks of the world are focused on handing out pain killers, instead of thinking in terms of: easing today’s pain, working on solving root causes and making future plans to avert the next round of crises.

It sounds like a tall order (it is) and it’s hard to think on multiple fronts in the middle of a crisis, but do we have any other choice if the alternative (Advil) isn’t going to solve any of the fundamental problems at the heart of the crisis?

Disclosure: at the time of publishing the author didn’t own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn’t be viewed as financial or investment advice.

Posted in Categories: Contributor, Economy, External Research, USA.

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