Our friend and economist house caller, Simon Johnson (along with Peter Boone and James Kwak), has a great post today on his site with some suggestions for how the government might handle this crisis better.
His post has an awful lot in it. What I like most is the suggestion that the Treasury Department tell us clearly what they are planning to do and why they are planning to do it. What sorts of banks will be rescued without question, which ones don't need full-out rescuing but can get that precious stock injection.
If I were investing in banks, I would have no idea what to think. Do I buy some bank stock with no way of knowing if they might collapse tomorrow or if the government might swoop in and help them up? Or maybe the government will choose some totally different approach all of a sudden?
For that matter, if I'm a bank, why would I lend money to some other bank if I know nothing about the health of that bank (they might own these lousy assets) and, worse, I have no idea what the government might do if that bank gets ill.
Markets and investors LOVE risk. Risk is calculable. It is what creates investment opportunities--you can make an informed bet.
Markets and investors HATE uncertainty. Uncertainty is when you have no basis with which to evaluate your investment. You have no way approaching an investment decision. Markets freeze.
How will Apple Computers perform next spring? I don't know. You don't know. But we can figure out a way to guess--we might disagree, but we're each willing to take a stab at it, because we know so much about what goes in to that question: there are all sorts of real-world, observable fundamental things that we can look at. We can have a view on how many people are going to buy computers and iPods; how Apple will do versus some of the PC companies. That is risk. It's not a guarantee, but it's measurable, you can guess with a basis.
What will Henry Paulson do next week? I don't know. You don't know. And you and I don't have any basis for guessing. We don't know who he is talking to or what his long-term goals are. We don't know what other power players in the Administration and in Congress and at the Fed are playing a role. We don't have any historical basis to think about these unprecedented events. There is no basic economic theory that we can apply. We have absolutely no idea and no way to get an idea. That is uncertainty.