Fidelity Select Fundranker

Fundranker Blog—October 2008 Archive

Two Opinions

Two opinion pieces in the October 9 NY Times point out both cause to worry about the financial crisis and reasons not to worry too much.

Paul Krugman, NY Times Op-Ed columnist and professor of economics and international affairs at Princeton University, calls this the moment of truth. He feels that the United States and European Union responses to the crisis have been woefully inadequate. Finally, though, the British government on Wednesday announced a plan to inject massive new capital into banks and provide extensive guarantees for financial transactions between banks, and now U.S. Treasury officials say they plan to do something similar, which Congress allowed in the rescue package, even though, until a few days ago, the U.S. Treasury remained resolutely opposed to it. He questions whether these moves are too little, too late, but hopes for a credible announcement this weekend of a new financial rescue plan involving not just the United States but all the major players. Because top financial officials from the major advanced nations are meeting today and the annual International Monetary Fund/World Bank meeting takes place over this weekend, Krugman says this is a golden opportunity for a new global rescue plan to be put in place.

Casey B. Mulligan, professor of economics at University of Chicago, makes a very different case. He contends that using some of the $700 billion in the rescue package to buy ownership stakes in banks is based on two faulty assumptions: first, saving America's banks won’t save the the economy, and second, the economy doesn't really need saving—it’s stronger than we think. He says the economy outside the financial sector is healthier than it seems and bases his reasoning on the profitability of non-financial capital, which economists call the marginal product of capital. When this measure of profitability is higher than average, future rates of economic growth also tend to be above average. Since World War II, the marginal product of capital has averaged 7 to 8 percent per year. In 2007 and 2008, when oil prices spiked and housing prices collapsed, the marginal product of capital was 10 percent per year, much higher than average. Mulligan also points out that third-quarter earnings reports from some companies already suggest that America’s non-financial companies are still making plenty of money.

Posted 10/10/08 4:06pm ET in Economy | Permalink | Comments (0)

Reverse Auction

To give maximum flexibility to the U.S. Treasury and the Federal Reserve, the newly legislated financial rescue plan is short on specifics on how the troubled assets will be priced and purchased by the government. A clever reverse auction process is one of the key ideas and deserves serious consideration. In this process, financial firms would offer to sell their troubled assets to the government at prices of their own choosing, and the government would buy the troubled assets in ascending order.

Presumably, the more anxious a financial firm is for help, the more they would lower the price they ask for their troubled assets. To make a reverse auction work most efficiently from the taxpayer viewpoint, the government would need to set up separate reverse auctions for various homogenous groups of assets, specify the total amount of money for each reverse auction, and set a maximum price it would pay for individual assets.

Posted 10/8/08 9:31am ET in Economy | Permalink | Comments (0)