The third economist

One local economist has a pretty good diagnosis but doesn't offer much in the way of a solution. Another economist offers a solution but I think it is the wrong one. The current downturn is difficult to diagnose and solve in a 500 word op-ed.

Dr. Grant from Lipscomb offers this...

There is a mistaken belief that falling home prices are the cause of the crisis in the financial industry. The real reason is the failure of many borrowers to live up to their loan agreements.

Ouch! That's true, but simplified. Increased foreclosures have driven home prices down. As soon as home prices stopped rising foreclosures increased. The initial foreclosures were primarily speculators - had little or no money down and counted on ever rising prices. As housing prices started to fall consumption decreased, the financial sector that held mortgages was rocked, and unemployment started to rise. The downturn has made it more difficult for others to pay their mortgage, people who were not speculating but maybe lost business or their job as the result of the downturn. It should be added that the distinction between a speculator and a responsible homeowner is unclear. All people who buy a home hope for appreciation and many tend to reach to buy as much home as possible, to leverage their money. The Lipscomb professor goes on to say...

Not understanding this, the Treasury Secretary wants to prop up home prices, and also wants to prevent foreclosures. To the extent that he succeeds, he will prevent the home market from adjusting to reality.

True again but simplified. It is understandable that policymakers are trying to prevent a further collapse of home prices. That will yield more foreclosures, less consumption etc. However, the housing market might still be over-priced. Generally we want rapid adjustment in markets. That's why I think we will see higher rates of inflation. With an increase in inflation we can have housing prices increase in nominal terms but continue to adjust in real terms.

Dr. Wahid from TSU wants to use all of the TARP money to buy up the toxic assets.

Thus, I suggest the government help financial institutions to clean up the toxic assets from their balance sheets with the entire $700 billion TARP fund. If the government does not do that, then to straighten out the bad balance sheets, it might take as long 10 years for the financial institutions to clean it on their own.

I prefer nationalizing the insolvent banks. Sounds bad to someone who prefers the free market but it shouldn't. It is like bankruptcy. When a firm is failing or struggling they can get bankruptcy protection. Bondholders, those who have loaned money to the firm are paid off at a steep discount. A judge often presides over the procedure. Often management is removed and the firm taken over by new owners. When it comes to banks the people who have loaned the bank money are not bondholders but depositors. Deposits are insured by the FDIC, the government. The government has an important role to play - come in, clean house, and sell it to investors in the private sector.