Friday, October 10, 2008

Fragility in the modern financial system

Some opinions seem to be emerging that not only are some individual financial institutions too big to fail but some are too interconnected to fail. See here for some rambling thoughts. From the link on Krugman's opinion:
Last month, when the U.S. Treasury Department allowed Lehman Brothers to fail, I wrote that Henry Paulson ... was playing financial Russian roulette. Sure enough, there was a bullet in that chamber: Lehman’s failure caused the world financial crisis, already severe, to get much, much worse.
The consequences of Lehman’s fall were apparent within days, yet key policy players have largely wasted the past four weeks. Now they’ve reached a moment of truth: They’d better do something soon — in fact, they’d better announce a coordinated rescue plan this weekend — or the world economy may well experience its worst slump since the Great Depression.

I am less optimistic than Paul Krugman in his piece. I think we've gone over the edge. I must admit I was overly optimistic that the financial effects could be contained within that sector and now I may be overly pessimistic. I think that herding and "animal spirits" have taken over. The fall in the stock market is too large not to affect the psyche of the public. Even Gretchen Rubin (who should know that happiness is not a function of stock market indices) has been checking the stock market. The best scenario out of this: a "lost decade" not unlike Japan and the Latin American countries for the world.

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