The Credit Crunch Story
By Arnold Kling
John Cochrane tells it, and he says,
Now that the short-termcredit crunch is over, the recession seems likely to be followed by a quick recovery, at least if the government does not get in the way with too many counterproductive attempts to fix things.
I think that is a basic problem with the credit-crunch story. The credit crunch is over. So how do we explain the awful economy? Possible alternatives:
1. The credit crunch was so awful that we are still suffering the consequences. Things would be even worse if the Fed had not fixed the crunch.
2. The credit crunch had little or nothing to do with the current state of the economy. We have to tell a different story, such as Recalculation.
3. It’s a timing issue. The bad economy we see now is the lagged effect of the credit crunch, and we will see a rapid recovery soon.
I know that the Recalculation story is not perfect, but would you rather defend (1) or (3) instead?
Cochrane, like many of us, wishes that the government had a credible way to avoid bank bailouts. To solve that problem Garett Jones, Ben Klutsey, and Katelyn Christ propose speed bankruptcy. That would involve a rapid conversion of debt into equity.
As you know, I am not satisfied with these sorts of technical solutions. I think that the larger problem is one of political economy. It is not that the regulators cannot restructure big banks that fail, it is that they will not do so. I think our best hope is to restructure big banks now, before they fail. Yes, the first-best market solution may be to let the market decide bank size and deal with bank failures, but we are not in a first-best world.