naked capitalism: Harvard, Princeton Economists Say No Fire Sale Prices, Premise of Public-Private Partnership Wrong

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We have been saying for some time that the policy premise of the Fed and Treasury has been that the financial crisis is that it is a liquidity crisis, not a solvency crisis. If you are of that school, the fallen prices of various assets is due to a combination of scarcity of funding plus irrational panic. Find ways to provide liquidity and give investors that magic elixir, confidence, and voila, crisis over.

Having watched the credit markets closely before the implosion, we'll agree there was plenty of irrationality. But it was in the gross underpricing of risk. The snapback to current pricing to us thus seems a return to rationality plus new fundamentals based on borrowers who never should have been lent money in the first place defaulting on such a scale as to damage overall economic activity. And that means, as plenty of Serious Economists (Krugman, Buiter, Stiglitz, to name a few) have warned, the Geithner cash for trash program is a huge misallocation of taxpayer dollars. Even granting that something must be done about the banking system, this is a covert and wasteful way to go about it.

That thesis has been validated by Harvard's Joshua Coval and Erik Stafford and Princeton's Jakub Jurek in a paper "The Pricing of Investment Grade Credit Risk during the Financial Crisis" (hat tip Bill Black). It looks at the repricing of investment grade credits, which is easier to analyze than structured credits (you have other claims, namely stocks, on the same entities, which allows for a relative analysis).

naked capitalism: Harvard, Princeton Economists Say No Fire Sale Prices, Premise of Public-Private Partnership Wrong

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