Don’t we wipe the slate clean after two generations or so? Or, as my old boss used to say, and he is looking smarter by the day, “We don’t repeat the mistakes of our parents; we repeat the mistakes of our grandparents.” Our monetary policy is being guided by fear of repeating the Great Depression. We may avoid that, and end up with two lost decades, like Japan. (it would fit the demographic trends…) Or, maybe, the FOMC will ignore (or suppress the knowledge of) inflation, and bring us back to an era reminiscent of the 1970s. Either way, we may face stagnation, but defaults are fewer in a 1970s scenario, though those on fixed incomes get hurt worse.
Don’t get me wrong. I’m not blaming Bernanke and the current FOMC much; the blame really rests with Greenspan, and the political culture that can’t take recessions, so monetary policy must bail us out. Consistently followed, it eventually leads us into a liquidity trap, or an inflationary era, or both.
Recessions are good for the economy; they clear away past imbalances. We should have been accepting them to a greater degree over the past 25 years. But now things are tougher, and most policy actions will lead to suboptimal results. Personally, if the FOMC could resist the political pressure, leaving Fed funds on hold at 3.0-3.5% would produce an adequate result 2 years out, with some increase in inflation, but allowing the banks to reconcile their bad loans.
The fear is that the FOMC will drop rates to Japan-like levels in order to avoid a Great Depression-style scenario, and create the Japan scenario as a result. My guess is that we would get more inflation than Japan, and not be able to do that. We are a debtor nation, versus Japan as a creditor nation; that makes a difference.
Patience is a virtue, individually and corporately. We are better off waiting and allowing monetary policy to work, rather than overdoing it, and setting up our next crisis.
As For A Financial Guarantor Bailout
The last time financial guarantors went broke in a major way was during the Great Depression. The financial guarantor stocks have rallied massively in the last few days, and I think those rallies are mistaken. There is much hope for a bailout of the insurers.
The insurers may indeed get bailed out, if the NY Commissioner can convince those that would get hurt to pony up equity, much as many of them are already hurting at present, but that equity would significantly dilute existing shareholders of the holding companies of the guarantors. I would not be a buyer of the guarantors here; I would sell.