Journal for today

After a fairly busy day at the office, discussing the upcoming business trip to Sydney, Brisbane and Jakarta, I went to Okawari bistro in Tokyo Midtown with Emmanuel from Paris, Wendy from Amsterdam, and Benn from London… it was a very international evening. Had a few beers then went walking around in the cold looking for a place to eat, and finally settled on an izakaya.  Had quite nice food and good discussion about different topics before walking my friends back to Kamiyacho and hopping in a Taxi home.  The taxi driver commented on my Japanese but he was being polite because he said that in English, ha ha.  Makes for a nice change though.  The highlight of the evening had to be receiving an email from N, asking me out to dinner with her tonight if I was available – it came at about 10pm though and I was already having dinner with the above mentioned.  Hmm… she must like me.   Helps inure me to the crap I have had to put up with from Y.   On other romantic news, I discovered today that I will be a free man on about May 17 or so, and so I am having a monster sized party that day.  Should be good.  

Credit crunch – the need for “purposive” intervention and increased disclosure in markets

The cause of the credit crunch initially and the difficulties experienced by markets and regulators to minimise its effects and contain it are related but different problems.   A “tipping point” was reached (interbank lending rates increased dramatically due to concerns that sub-prime mortgage defaults would increase) and a new dynamic situation was created – it is the dynamic situation that is the continuation of the credit crunch and what must be dealt with before a longer term solution or regulatory intervention implemented.  The approach so far has been for market regulators to resort to emergency bail out financing or similar tools.  I want to offer an opinion about the approach that should be adopted to any regulatory intervention.

Emergency bail out financing (or conditions that lead to it) is economically rational only if done with a view to correcting a market into a shape that can, ultimately, function without the need for such emergency bail out financing again (on balance) given the same conditions.  Otherwise, a particular financial institution should be allowed to fail so that the market can, ultimately, correct itself.  (I am assuming an allocative efficiency model of rationality in a market).

The problem with the current credit crisis, however, is that even if this approach was adopted there is no certainty within the broader economy as to what the scope or boundary is of that market.  Therefore the risks cannot be determined or priced and there cannot be a rational  allocation of resources.

It is not because the relevant financial products are complex – their complexity has not increased or decreased in recent times – but that the complexities exist in markets or sub-markets that do not require or permit (or have)  full disclosure of sufficient information about the size scope and operation of the markets in which those financial products are functioning.  Without such disclosed information it is impossible for any market to naturally correct itself.  Therefore, the rational response is to withdraw from a market until it stabilises – which just means until the definition of the market(s) becomes clearer and the risks involved in participating in such market can be assessed and priced.   This is why there is a credit crunch. 

Therefore, emergency bail out financing is rational if it is done as part of a plan to require the increase in the level of relevant information that must be disclosed by market participants regarding the products that are functioning in and across markets to such a sufficient degree as to permit participants to price various risks.

FYI, I was drunk when I wrote this