Nov 25, 2008

Preservation*

The argument over whether to call hundreds of billions of dollars flowing out of government coffers and into private banks a "bailout package" or "rescue plan" seems short-sighted to me. Neither term does a sufficient job of capturing the consequences of what's being done, and both imply a positive outcome.

A better and more frightening term is "preservation plan." In trying to prevent a complete meltdown in the financial sector we are preserving a system that is not sustainable.

In some ways our response to the credit crisis reminds me of our decision to fight fires in once remote wilderness areas. Intervention becomes necessary because we have chosen to develop next to forestland. At the same time, intervention interrupts a natural process, making future fires burn hotter and more destructively. Logic says we should let the fires burn, but that means putting people's homes and lives at risk. Preserving homes and lives increases future risk and encourages more building next to forestland.

The risk of failure in resolving the short-term crisis seems to require that we ignore the long-term consequences. How does one undo a cycle of bad decision-making after the cycle has begun?

This financial crisis appears to be circling in the same vicious manner. Intervention becomes necessary because we have become dependent on consumer spending and rising home values to keep our economy moving, and avoid a massive recession, bank failures and job losses. Intervention means propping up a consumer economy that demands more and more injections of credit to survive, whether they come from the government or mortgages or credit cards. Logic says we should let the whole mess collapse on itself, but that puts people's homes and lives at risk. Preserving homes and lives increases future risk and encourages people to go on spending the way they had before.

After all, what will the solution look like but a return to what we now consider to be normal?

*UPDATE: Just how addicted are we to credit? Banks continue to hand out credit cards with limits that have no bearing in reality, despite a rising risk of defaults. An anonymous banker complains to the New York Times that until banks start checking to see if customers can afford to pay back their lines of credit, the cycle of failure will continue. Which means more fires to put out.

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