the problem is perceived risk, same thing when worldcom and enron went belly up. the TED spread and all the other indicators went crazy because everyone stopped trusting everyone else because no one trusted the public financial info. everyone went into bunker mode and conserved cash and didn't lend it to anyone.
same thing happened last week. people started pulling money out of MM's because everyone believes it's as safe as cash and the details don't matter. what matters is the effect it has which is no short term lending and the possiblity of MM's going belly up which is even worse. If the Fed allowed the risk part to happen and MMs to go belly up it would have been very bad.
imagine the only people getting credit are only those with 800 or higher FICO's? fortune 500 corporations would have cash problems because everyone relies on short term financing for working capital. there is a formula i learned in finance classes that is used to figure this out, but i can't remember it. you can figure out a company's working capital requirements from it's public investor documents.
if you look at your average fortune 500 company the bonds usually yield around 4%. the way the libor was last week that might double. now imagine if the government allowed things to go on and institutions to keep on failing. at the minimum it could have been a recession like 1980 with 10% unemployment.
the meltdown comes from the fact that everyone is linked to everyone else via credit default swaps. rumor is that the bear stearns bailout was really a JP Morgan Chase bailout because Chase had around $80 trillion of CDS's with bear stearns. once institutions like AIG fail everyone calls in their IOU's via CDS's and forces everyone into bankruptcy as no one can pay up and each BK will cause more BK's down the line.
Then you have the problem with the Federal Reserve stretching it's balance sheet with all the junk they took on over the last year from the banks. this bailout will go forward because it's as much a Federal Reserve bailout as wall street. no one has the money to pay the Fed back for the loans they made over the last year and this is how it's going to work out.
i bet if you add up all the lending facilities over the last year it will add up to around $700 billion. and you can't seriously say we should let the Federal Reserve fail? Last time we got rid of a central bank it turned into a 20 some year depression, a war with mexico, and hatred between the states that later turned into the civil war.
(My bold) I don't think that "everyone" relies on short term financing. See this, for example:
www.latimes.com/technology/la-fi-microsoft23-2008sep23,0,1847736.story?track=rss You can look at public documents and figure out how much working capital a firm had in the past, and see if the curent amount is high or low relative its history, but I don't think there's a formula that tells you what they "should" have.
I'm picking on this point because it's a good example of choices. Businesses make a choice on how much leverage they are going to use, and how much of the debt will be short term. Firms that use lots of short term debt will show better profits in good times and worse in bad. An occaisional "credit crunch" keeps people from going overboard. The firms that emphasized equity ride out the storm and expand at the expense of those that were heavy with debt. Our root problem may well be that we've had good times for businesses with low interest rates for a long time, so perceptions of "safe" levels of debt have become pretty high.
I understand that when things go bad people get conservative and try to build cash. This effectively shrinks the money supply and the Fed should do something to offset it.
Theoretically, it's possible that so many firms are so highly leveraged that there would be a chain reaction of bankruptcies. That worries me more than Money Market funds. I'm questioning whether we're in that situation. Are most firms really that dependent on that much debt? or are we at a point where some highly leveraged firms are going to fail while the others endure a bump in the road? The problem is that the "experts" who should know those answers seem to be the same people who will profit from the bailout. I'm not sure if we're getting an impartial analysis. I haven't seen a poll of the academic "experts", but I happened to hear one "free market fan" last night who says we shouldn't panic (see Meltzer at:
www.pbs.org/newshour/bb/business/july-dec08/bailouttalk_09-23.html
(I'm not worried about the Fed - it owns the printing presses.)
I notice that Lehman seems to be finding buyers for its parts. Merrill and GS are doing painful things that don't involve bankruptcy. I hope we find out soon if most of the pieces of AIG turn out to be sellable.
I can remember the 10% unemployment rate in the 80's. It wasn't a good thing, but it was the cost of squeezing decades of inflationary psychology out of the system. In the long run, it seems to have been worth it. I hope we don't get that high this time (I've got a family with jobs on the line, and the US has more economic inequality now then we did then.), but maybe it's time to squeeze the "it doesn't matter how much you borrow" psychology out of the system.