A liquidity crisis or an insolvency crisis?

I don’t understand all of this discussion, not by a long shot, but it usefully explains the basic outlines of the debate between the administration, which thinks the properties underlying the mortgage-based securities are still worth a lot and that the banks just need a shot of capital to get the economy moving again; and Paul Krugman, who thinks the banks are insolvent and the only thing to do is nationalize them.

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March 30

A. Zarkov writes:

An insolvency crisis. In this case I agree with Krugman—we have many banks that are insolvent. This is also the position of many other economists such as Nouriel Rubini.

The excellent interview with John Cochrane conducted by Russ Roberts is available as a podcast here . You can listen to it with your browser or download the audio file and play it on an Ipod or equivalent. Some of the highlights of the interview are transcribed at the link. But I recommend listening to the entire talk as it covers much of the basics of what has happened to the banking system and the general economy. It deals directly with the issues raised on the Powerline blog. You will need to devote an hour of your time, but in my opinion it’s well worth it. These interviews are excellent ways to learn what some of the academic economists are thinking. They tend to be less formal and more direct than when they write academic papers. Russ asks great questions and makes sure the interviewee explains something that the general listener might not understand at first.

Krugman favors the stimulus package which Cochrane opposes along with many other economists. We have a real division within the community of academic economists—some very heavy hitters oppose the stimulus package, but don’t get as much publicity as those who favor it. Here is a debate between Bradford DeLong and LuigiI Zingales on Keynesian fiscal policy to deal with the recession. DeLong is an ultra liberal, but not a socialist.

Karen writes from England:

Here is a good article which explains that the banking system is insolvent due to the 1.5 quadrillion worth of derivative contract liabilities. The term “toxic assets” is a euphimism for derivatives. The subprime mortgages are just a small part of the story and are not responsible for the collapse of the banks. They are but one form of derivatives. The major problem is the CDS liabilties. Thus the crisis goes beyond a liquidity problem and essentially the whole banking system is insolvent.

Posted by Lawrence Auster at March 29, 2009 11:29 PM | Send