What is an Asset?

I like Brad DeLong, conceptually. Even his errors in judgment are based on rational principles. And he has a really useful piece up right now about “dealing with financial crises.” (One of the nice things about it is that it also completely undermines his earlier suggestion that the Fed was wrong not to ease on Tuesday. As Mark Thoma and I, among others, suggested, they clearly knew it would do no good, and “saved their powder” accordingly.)

There are only a few problems, key of which is the title of this piece. Derivatives may have a value, but are they actually assets? Worse, if the Fed buys an asset, does it also have to buy all of the associated derivative contracts, one side of which may—by that simple—become worthless or become payable?

I’m not suggesting that Helicopter Henry and Biplane Ben’s $100B inflation solution isn’t going to work,* but if you’re trying to limit contagion, you generally don’t start by infecting healthy entities.

Of course, that assumes the entities are healthy. The commenters at Infectious Greed have gotten more astute as the day goes by:

AIG, Leucadia, Loews, Berkshire Bancorp and Berkshire Hills Bancorp (gotta protect the high ground!) but not Berkshire Hathaway, AmEx or Capital One. Also Affiliated Managers Group and Pzena but not Legg Mason. Fascinating; like a train wreck in progress.


That “do not short” list is basically the list of companies you must to sell if you have any of them in your portfolio.

Or, as an old friend just e-mailed me, “So. I see there’s a list of 799 financial forms that cannot be shorted….that is by no means all the financials in the US market…is there any reason at all that we shouldn’t take this as a list of financial companies KNOWN TO BE UNSOUND?”

So maybe I shouldn’t be worrying so much about possible contagions.

DeLong rather cavalierly, though, throws out a straw man to reject it:

Fourth, there is now no time for tolerance of the three objections to this analysis and this plan of action, roughly: (1) it’s immoral, (2) it’s unfair, and (3) it can’t work in the long run. To expand a bit:

1. It’s immoral because people have a right to be treated like adults–which means that they have a right not to be rescued by the government from the consequences of their bad judgment, and we are violating that right.
2. It’s unfair because feckless greedy financiers who caused the problem ought to lose money and aren’t–or aren’t losing enough money–and because feckless greedy imprudent thriftless borrowers who caused the problem ought to lose money and aren’t–or aren’t losing enough money.
3. It won’t work–at least not in the long run.[emphasis mine]

Let’s ignore that, given that he dismisses (1) and (2), (3) becomes inevitable. Let’s even grant (1)—while noting that he deliberately phrased to place it in the poorest light possible—since a bailout is necessary,** and targeted bailout isn’t going to work.***

Let’s just say #2 sticks in my craw a bit. Especially if you’re making the absurd claim that there “is now no time.”

Helicopter Hank and Biplane Ben have had six months since The Old Firm went the way of all Southern Pacific Railroads. During that time, they have created Special Purpose Vehicles (SPVs) like a derivatives shop on Gramm-crack. They have red-socked**** us more times than we can count to provide nearly a billion dollars worth of liquidity so that those risky assets could be managed, marked appropriately, unwound, or sold.

And now they’re going to throw “hundreds of billions of dollars” more into the giant Money Pit that is ever-increasing its lending standards to companies that are far better run than they are.

And Brad DeLong has just declared that we shouldn’t hold anyone responsible; indeed, the Hank Greenbergs and Dick Fulds and Jimmy Effing Caynes of the world should continue to be rewarded by the U.S. taxpayer, because “there is no time.”

So, Brad, when you tell us that we don’t have the time to hold people responsible for their actions, and we tell you it won’t work in the long run, remember the reason we’re saying that. Because, in pre-Paulson/Bernanke economic theory, actions used to have consequences. Now, they can just cost the taxpayers.

And when I add that to your final graph—the one that is supposed to get us back to that “good equilibrium” point—I stop seeing it as an intertemporal equilibrium point and more as an outlier from the payoff-dominant strategies you are effectively advocating be concretized.

*It’s not the way to bet, but you go to war with the policies you have.
**Just as it was for Argentina in 2001 and…what…Washington Consensus? Sorry, no habla ingles.
***We shall ignore, since he does, that the reason targeted bailouts didn’t work is that companies smelled blood (money) in the water and decided to go for it, leaving us with Chris “stocks can only go up” Cox bending the U.S. taxpayer over a little more.
****Trust me, if you don’t know this phrase, you do not want to look it up. Assume from context.