Bagehot is (still) dead

Fed Head Ben Bernanke has stated that he agrees with Bagehot in principle but that the high interest rate was only to discourage unnecessary lending that would strain England’s limited resources. Under Bernanke’s theory, the U.S. now has nearly unlimited resources therefore the interest rate should be more reasonable. This argument has several assumptions. First, inflation is not a concern. In dealing with a financial crisis, short term goals are driven by irrational fear leading to poor decisions such as those made by the patron saint of unintended consequences, Alan Greenspan. Inflation should not be the priority but it should be a factor. Second, increasing the national debt is not a concern. We cannot continue to believe that the U.S. will be capable of growing its way out of debt since we are unlikely to be the economic beneficiaries of another few world wars. As a taxpayer watching the baby boomers spending my future social security benefits, no one seems interested in a plan that would not be either the mother of all tax increases or the elimination of social benefits before I reach retirement. Third, if GE and Goldman are willing to pay a 10% dividend on preferred stock with warrants to boot in order to access capital from Berkshire, why should we accept losing money on ANY deal. Even assuming government workers are incapable of securing comparable agreements due to incompetence or the mistaken assumption that businesses need to be incentivized to save their sorry asses, we should at the very least demand that if the government is going to nationalize the financial system, it needs to be more profitable than the system it replaced. Otherwise, what the hell is the point.

A “Loss of Value”

The media keeps harping on how more than $1 trillion in value has been wiped out by the market over the past week. While prices are cheaper, the market neither creates nor detroys value. For those skeptics out there, consider the marginal analysis. As numberous academics and practicioners have written, stocks follow what is descibed as Brownian motion in the near term. This means that each tick up, down, or constant can best be described as random and only in the longer term does the general direction of price movements become apparent. Should the marginal tick which is best described as random be credited with creating or destroying value? No. Companies create value through good management of resources. The stock market has nothing to do with value creation. The market is a mechanism for price discovery.