Ideation

I guess what we need is a good ol' fashioned dose of socialism.

As the credit crisis has slowly expanded and worsened, there has been a flurry of activity in Washington to reduce the damage from it. There are bailouts and tax breaks, and even checks to parents of school-age children.

But there is remarkably little action aimed at getting the credit system functioning again.

In part, that is because there is a scarcity of ideas. Paul Volcker, the former Federal Reserve chairman whose legacy has not crumbled since he left office, was right this week when he said the financial engineers had created “a demonstrably fragile financial system that has produced unimaginable wealth for some, while repeatedly risking a cascading breakdown of the system as a whole.”

But it is far from clear what should replace it, or if it can somehow be mended.

To be sure, we had a system that worked for generations, based on commercial banks constrained by regulation. But that system is not coming back, as Mr. Volcker noted in his extraordinary speech to the Economic Club of New York this week.

“Any return to heavily regulated, bank-dominated, nationally insulated markets is pure nostalgia, not possible in this world of sophisticated financial techniques made possible by the wonders of electronic technology,” he said.

In any case, the banks are not all that healthy anyway, thanks to their losses from the strange securities created under the new system.

For the time being, the solutions being pushed would not seem unreasonable to an old-fashioned socialist. Most new mortgages are now guaranteed by the government or by government-sponsored enterprises, whose ability to lend is being expanded.

The Bear Stearns precedent seems to assure that investment banks have joined commercial banks in the Fed’s safety net, and the Fed has now taken control over what Mr. Volcker calls “mortgage-backed securities of questionable pedigree.

Floyd Norris concludes with a swift parting shot to "The Oracle."

There is a real risk that the ad hoc efforts now being made to deal with this crisis will create other problems. Mr. Volcker, who knows how inflation can get out of hand, said the current situation reminds him of the early 1970’s, when inflation began to accelerate. The Fed’s moves to slash short-term interest rates and bail out Wall Street, however necessary they may be, could easily raise inflation and cause more damage to the weak dollar.

It is striking to realize that while Mr. Volcker has been gone from the Fed for two decades, he is, at 80, two years younger than his successor, Alan Greenspan. Had Mr. Volcker somehow kept the job, he almost certainly would have been more skeptical about the new financial architecture — and less popular on Wall Street — than Mr. Greenspan was when times were good. But the bad times we are now entering might not have become nearly so large a threat.

Norris does say finger-pointing is inappropriate as no one could foresee the severity of the crisis. Maybe so, but as his final paragraph indicates, Greenspan and his then-deputy, Bernanke, could have tried to cool things down when it was clear the housing market had hit the red zone.