Flutterby™! : the liquidity crisis

I'm leaving town shortly, back on Thursday, so I don't have time to watch this Harvard panel discussion on economics, but Elizabeth Warren's pointer to it says:

At a Harvard panel discussion yesterday, economist professor Ken Rogoff made an interesting point: The liquidity crisis isn't real.  Or, to restate it: Any liquidity crisis is caused by the promise of a government bailout. Ken said that his many friends in investment banking said that there is plenty of money to invest in financial services, but right now it is "sitting on the sidelines."  Why?  Because the financial services industry does not want to pay the terms required to get that money back in circulation (e.g., give up equity).  As he put it, why do business with Warren Buffett who will negotiate a tough deal, if you believe that the government will ride in soon with cheaper cash?

[Edit: The comments to that entry say it was actually Greg Mankiw, and claims that Elizabeth Warren took it out of context, now I really wanna see the video]

To me it seems like... well... a parable:

We live in a neighborhood. Maybe not the best neighborhood in the world, but it ain't bad, and people from other neighborhoods are clamoring to live here, so we're kinda happy here. Some folks starts to build a high rise in our neighborhood. At first we're a little concerned, 'cause we do occasionally have natural disasters here, but the promises of how modern buildings are going to turn our little neighborhood into a very desirable city in a few years keep us from protesting too loudly. Yeah, the engineering looks a little shakey, in fact one of the guys working on this building even refers to the idea that it can be built as high as is planned as "irrational exhuberance", but construction continues.

It seems like this building has hit a reasonable height, but down the street a used car dealer comes in and says "hey, you can use scrap steel from my used car business to build that thing even higher!". Many of our neighbors say "great, I'm gonna get a condo in that building". Soon, some of us who were uneasy with the building in the first place start to notice that a disproportionate number of people seem to be dying in crashes of cars bought from the used car lot, so we start to look closer at the building. And now we notice that if the building falls over, it's gonna wreck a good bit of our neighborhood, crush our houses and shrubberies.

And we start saying something.

Now the guys building this building and the guy with the used car lot catch on to this and say "Woah! This building's on shakey ground! We need everyone in the neighborhood over here, quick, to hold this building up! We need to buy lots of support to keep this building from collapsing all over the neighborhood!"

And those who have had second thoughts about this building are starting to say "well, why don't we take a couple stories off the top, rather than just putting temporary reinforcements around the bottom?" Of course our neighbors who bought condos in this building are hollering at us that if we take stories off the top, they'll lose their condos, so they're siding with the used car guy.

No matter what, you don't take the first deal you're offered by the used car guy. And, indeed, collapse may be imminent, but it seems like double-checking the engineering of the people who brought us the unstable mess is in order before we start slapping 2x4s on the first story of this skyscraper to figure out how to really keep this thing from falling over, or at least to figure out how to take off a few of those unsustainable stories safely.

Oh, and if I hear one more person blaming tranches and bad rating systems on the 30 year old legislation that is the CRA, I'm gonna have to lay about with me with a clue stick. I'm not necessarily a fan of the CRA, but the arguments I've seen blaming all the sub-prime lending by non-CRA conforming organizations on the CRA are beyond absurd.

[Edit: Fixed "tronch" to "tranch" spelling]