Credit is the creation of new money based upon the presumption that the borrower will be able to create the material wealth to back the new money issued. When money is created based upon credit instruments rather than upon material assets this creates a multiplier where the new "money" created will far outstrip the ability of the original borrowers to create new wealth.
The Federal Reserve is responsible for overseeing our nation's money supply. They had the right and responsibility over the last decade to intervene in these new markets or at least a strong obligation to be screaming to congress about the dangers. Note that in these last couple weeks Bernanke was running around Congress with his hair on fire. Greenspan and Bernanke have drastically dramatically failed in their prime obligation of oversight of our money supply.
To look where we are and stop pointing our fingers at the past (where have I heard that meme floated recently?) the question is what do we do now.
It actually does make sense to buy the most "toxic", highly leveraged and least valuable (as related to real assets) of such instruments and flush them. This removes the most "funny" money from the system at the lowest cost. It is certainly inequitable from a zero-sum view of economics and rewards those who did the most damage. But economics is not a zero sum game. This really is the best strategy - short of declaring such instruments null and void - for destroying the most of this "funny money" in the shortest time - Bernanke does know what he's doing with this bailout - and it is the FR being bailed out even more than Wall Street..
There will still be far more "money" in circulation than can be grown as material wealth in the economy by the time the remaining instruments become due. High Inflation is both necessary and inevitable. But the slowdown of the economy will at the same time create deflationary pressures greatly exacerbating the problem since traditionally expanding the economy is achieved by increasing the money supply. Today's problem is not a lack of money, but a concentration of money (funny money, but real in economic consequence) in institutions and vehicles which lock it away from investments that grow material wealth enterprises.
The next administration will have its hands full trying to deal with this mess. The biggest and most necessary trick is to get that funny money growing the "real" economy in the least amount of time. The first order of business is to find a means of discerning between income on credit wealth versus wealth created by investment in goods. Unfortunately any such distinction will be somewhat artificial, but if we can find a workable one taxing the former at a high rate while rewarding the latter is mandatory.
One such measure with political resonance would relate revenue to the number of employees and employee compensation. When the difference between revenue less raw materials exceeds some number - say quarter million - per employee, then the excess between that end employee compensation (capped by individual employee) should be highly taxed. Similarly financial institutions should be rewarded for investments in companies meeting this metric and disincentivized fof chasing money rather than wealth (consumable goods and services). A short term emergency wealth tax along similar lines should also be considered. Yes the neocons will argue - correctly - that this discourages people from making money. But that's the problem; we've allowed the creation of money in preference to the creation of wealth. As the foreclosure rate shows, we've now actually reached the point where the incentives for creating money are actually destructive to the creation and maintenance of real wealth.
As a country we need to dramatically change our policies so that they reward the creation of wealth far more than the creation of money.
-- TWZ
http://www.zensden.net/...
Minor update: "Bad money drives good money into hiding". For days this has been tickling my brain but it only surfaced after I published the diary. It's called "Gresham's Law". It's exactly what's happening now. The Wall Streeters printed so much of their funny money that they've had to swallow the "real" money to protect themselves, leaving no credit available for the real economy.