The Last War

The WSJ has an interview with Anna Schwartz, Friedman's coauthor on A Monetary History of the United States. She has some interesting remarks.

Today, the banks have a problem on the asset side of their ledgers -- "all these exotic securities that the market does not know how to value."

"Why are they 'toxic'?" Ms. Schwartz asks. "They're toxic because you cannot sell them, you don't know what they're worth, your balance sheet is not credible and the whole market freezes up. We don't know whom to lend to because we don't know who is sound. So if you could get rid of them, that would be an improvement."

But she's wrong. A toxic asset you don't know how to value and can't sell is completely utterly familiar to bankers. It's called a non-performing loan. And these assets can be sold. It is just that banks don't like the price at which deals - like Merrill with Loan Star - can be done. There are two solutions. Either sell at the market price and move on, if you can afford it, or recapitalise sufficiently so it is utterly obvious the bank can afford to hold to term, and wait and see what happens. The latter is cheaper as you don't have to pay an uncertainty premium, which is why the Brown/Darling plan rightly concentrates on recapitalisation.

Now we get to the usual free market bollocks:

Rather, "firms that made wrong decisions should fail," she says bluntly. "You shouldn't rescue them. And once that's established as a principle, I think the market recognizes that it makes sense. Everything works much better when wrong decisions are punished and good decisions make you rich." The trouble is, "that's not the way the world has been going in recent years."

She can say that after Lehman? And still get an interview in a supposedly serious newspaper? That's simply embarrassing. The reality is that if senior obligators of large firms are too spooked right now, the system fails. So, let's remember that firms have a capital structure. We can, and should, screw equity holders of firms that made bad decisions. We can, and should, save senior debt holders in large banks (and anyone pari passu with them).