Financial Crisis Will Deepen Until Trust in Free Market is Restored

The worldwide financial crisis isn't about the subprime meltdown, although it might have first surfaced there for all to see.

It is not even ultimately about derivatives, although derivatives are by the largest risk numbers-wise (indeed, the nominal value of derivatives dwarfs the size of the world-wide economy).

It is - at core - a crisis of trust.

As long-time financial writer Will Hutton says:

"Such was the break down in trust and sense of panic that some of the most familiar names in British high street banking would not lend to each other at all or, at best, just overnight. Instead, the Bank of England had to supply tens of billions to banks who found the normal sources of funds blocked.

***
Unless there is a radical and government-led change in ownership, structure, regulation and incentives so that the principles of fairness are put at the heart of the Anglo American financial system - proportionality of reward and fair distribution of risk - there is no chance of the return of trust and integrity upon which long-term recovery depends."

Princeton economist and former Secretary of Labor Robert Reich agrees that Wall Street's biggest problem right now is the collapse of trust:

The problem is, government bailouts, subsidies, and insurance aren't really helping Wall Street. The Street's fundamental problem isn't lack of capital. It's lack of trust. And without trust, Wall Street might as well fold up its fancy tents.

And as prominent economist Nouriel Roubini writes:

"It is obvious that the current financial crisis is becoming more severe in spite of the Treasury rescue plan (or maybe because of it as this [bailout] plan is totally flawed."

In other words, the financial crisis is worsening because the government is offering proposals based on obvious lies, which will not actually fix anything. Paulson and Bernanke and company are lying - just like the scam artists on Wall Street were lying . . . it's just more of the same.

The crisis will deepen unless real productive manufacturing and service jobs return as the foundation of our economy, honest and transparent accounting is used, and the government stops gaming the system for the benefit of the wealthiest 1%.

As John Carney writes:

"We're probably making things worse. Allowing insolvent institutions to fail and requiring worthless and worth less assets to be fully written down would provide transparency to the market. Instead, we're dedicated to the post-Lehman proposition of "Never Again." The various programs of our government continue to obscure asset pricing and conceal insolvency. This means that you can't trust the market to tell you which firms are failing.

Twisting the arms of bankers to lend to institutions that may be insolvent is a recipe for deepening the crisis. We've just been through a period of malinvestment--we spent too much borrowed money on junk. Borrowing more to spend on junk only digs us in deeper.

Bank lending won't get going again until trust in the markets can be restored. Fighting a Great Depression era problem probably won't help. More transparency, which means more write-downs and failures, is probably necessary if we're going to get through this. Unfortunately, we're still sailing in the opposite direction."

See also this.