Brad DeLong on the Crisis
By Arnold Kling
In normal times, our models predict, with the ability to diversify portfolios that exists today the risk discount on assets like corporate equities should be around 1% per year. It is more like 5% per year in normal times — it is more like 10% per year today.
Read the whole thing. I give Brad a lot of credit for steering clear of IS-LM analysis and trying to re-think macro from the ground up.
In my important 9th lecture on macroeconomics, I said that the financial sector tries to hold long-term, risky assets and issue short-term, risk-free liabilities. What has been going on this year is a massive reversal of that. Financial institutions are fighting and clawing with one another to shed long-term, risky assets and instead acquire short-term, risk-free assets. The financial sector has become dysfunctional in a really major way.
The trick is to right-size the financial sector while slowing down the pace of de-leveraging. In my opinion, the bailouts and rescues are not helping with either process.