About $1 trillion of taxpayer funds are committed to rescuing financial firms that made bad decisions. The officials at the Fed may claim that the government’s getting control of valuable assets and that all will be fine when markets calm down. Can we be sure?
The private sector is unwilling to purchase those same assets. The lack of transparency about asset quality involving immensely complicated derivative structures has even financial experts perplexed. Why do we think that the Fed would do a better job?
To be sure, the Fed and Treasury might only be performing their function of lenders of last resort. When financial firms cannot sustain their values, the government must step in. Otherwise, credit to good production enterprises–main street firms–may dry up and the economy will tank. But it still raises fundamental questions about the government’s role in markets, contingent fiscal exposures and moving targets.
Unfortunately, there’s no guarantee about when the private demand for mortgage‐backed assets enmeshed in complicated derivative contracts will recover, because there’s no transparency about their value. Nobody–not the credit rating agencies, private CFOs or government financial experts–has any way of sorting out relatively soon what these contracts contain in terms of the reliability of underlying financial flows.
All of this will take time to sort out, so the “orderly resolution” of these financial instruments–value discovery and placement with proper institutions that can tolerate the risks–will take many months. And here’s the bottom line–the problem is likely to become worse in the meantime and the Fed and Treasury have no mechanism to call for a “time out.” The hope here seems to be that merely the passage of time is needed for markets to settle down.