Explaining Financial Crises Through Metaphors

When you’re talking about spending on the order of $700 billion to prevent bank collapses that could have adverse economic consequences, one question that naturally arises is whether we couldn’t avert those consequences by deploying the $700 billion directly rather than through the mechanism of shoring up failing banks. Alex Tabarrok says he thinks we could:

A credit crunch does exist in the sector of the market based on short-term, asset backed securities. In addition, interbank lending is unusually risky. But in light of what I have just said the “credit crunch” takes on a new meaning and potential new solutions are suggested. The first question I have is this. Investment banks were selling these securities and using the money to lend to whom? I do not know the answer. But let’s suppose that the money being raised in these markets was being lent to productive businesses. If so, then any solution should focus on feeding those businesses that are starved for credit.

I look at the situation as follows. Banks are bridges between savers and investors. Some of these bridges have collapsed. But altogether too much attention is being placed on fixing the collapsed bridges. Instead we should be thinking about how to route more savings across the bridges that have not collapsed. Government lending may be one way of doing this but why lend to prop up the broken bridges? Instead, why not lend directly to the investors who are in need of funds? After all, if these investors exist and have valuable projects that’s where the money is! Let the broken bridges collapse, taking the shoddy builders with them. Instead focus on the finding and rescuing the victims of any credit crunch, the investors who need funds.

I’m not sure that’s right, but before signing off any any $700 billion expenditures, the wise member of congress will ask the requester to evaluate several different possible options for action on that scale along with an explanation of why, specifically and in detail, the requester thinks his preferred option is better.