Saving The System

The Economist wants to implement item #5 of the Communist Manifesto in Saving the System

Centralization of credit in the hands of the State, by means of a national bank with State capital and an exclusive monopoly.(Marx 1959, 342)

The magazine diagnoses the problem as:

... Today’s failure of confidence is based on three related issues: the solvency of banks, their ability to fund themselves in illiquid markets and the health of the real economy. The bursting of the housing bubble has led to hefty credit losses: most Western financial institutions are short of capital and some are insolvent. But liquidity is a more urgent problem. America’s decision last month to let Lehman Brothers fail—and the losses that implied to money-market funds that held its debt—prompted a global run on wholesale credit markets. It has become hard for banks, even healthy ones, to find finance; large companies with healthy cash flows have also been cut off from all but the shortest-term financing. That has increased worries about the real economy, which itself adds to the worries about banks’ solvency.

Emphasis Mine

Credit allows the early conversion of commodities into money. Instead of waiting for the goods to be sold to the ultimate consumer, and money returned to the manufacturer, credit allows for the partial realization of profits at every stage of the movement of goods from the factory to the consumer.

Credit, in itself, is not the problem: it is the management and allocation of credit among the various debtors.

In a banks run along capitalist lines, credit is allocated where the preceived profit is the greatest, not where the need is the greatest. The enterprise must do this in order to survive otherwise another enterprise with a larger capital base innovate and undercut it.

The negative feedback to this progression is risk. The higher the rate of profit should be correlated with the risk that the investment may fail. Government regulation tends to make banks aware of what types of risks they can undertake.

The specifics of the plan are:

This analysis suggests that governments must attack all three concerns at once. The priority, in terms of stemming the panic, is to unblock clogged credit markets. In most cases that means using central banks as an alternative source of short-term cash. This week the Fed took another step in that direction: by buying commercial paper, it is now in effect lending direct to companies. The British approach is equally bold. Alongside the Bank of England’s provision of short-term cash, the Treasury says it will sell guarantees for as much as £250 billion ($430 billion) of new short-term and medium-term debts issued by the banks. That is risky: if left for any length of time, those pledges give banks an incentive to behave recklessly. But a temporary guarantee system offers the best chance of stemming the panic, and if it were internationally co-ordinated it would be both more credible and less risky than a collection of disparate national promises.

The second prong of a crisis-resolution strategy must aim to boost banks’ capital. A new IMF report suggests Western banks need some $675 billion of new equity to prevent banks from rapidly reducing the number of loans on their books and hurting the real economy. Although there is plenty of private capital sloshing around, there is a chicken-and-egg problem: nobody wants to buy equity in an industry without enough capital. It is becoming abundantly clear that government funds—or at least government intervention—will be necessary to catalyse the rebuilding of banks’ balance sheets. Initially, America focused more on buying tainted assets from banks; now it seems keener on the “European” approach of injecting capital into their banks. Some degree of divergence is inevitable, but more co-ordination is needed.

Third, policymakers should act together to cushion the economic fallout. Now that commodity prices have plunged, the inflation risk has dramatically receded across the rich world. With asset prices plummeting and economies shrinking, deflation will soon be a bigger worry. The interest-rate cuts are an important start. Ideally, policymakers would not use only monetary policy. For instance, China could do a lot to help the rest of the world economy (and itself) by loosening fiscal policy and allowing its currency to appreciate more quickly.

Emphasis Mine

This is socialist intervention of a colossal scale but without taking control of the banks. The governments are intending to be passive investors which means that the risk of moral hazard increases not decrease (as noted above).

References

Marx, Karl. 1959. Capital, the Communist Manifesto and Other Writings. Ed. Max Eastman. New York: The Modern Library.