http://tinyurl.com/3paq8t

market prices, driven by deleveraging, a cash squeeze, flight to quality and sheer panic, are no useful guideline to solvency.

but as marshall auerback rightly points out above, “hold-to-maturity” valuations are equally useless if these are based on cashflow forecasts, the assumptions of which (most important of which is whether we are headed into an enormous economic slump) are totally uncertain.

but the problem is not simply “price discovery”. the problem is very real “value destruction”. put simply, the financial crisis is doing brain damage to the economy. how governments and markets respond to stabilise the situation will itself do a lot to determine true value.

i personally am a big subscriber to soros’ approach, which is based on the fundamental observation that the idea of a “market equilibrium” is a sham. value does not just drive prices – the opposite can also be true, especially when a financial crisis can turn into an economic depression.

we can all agree that house prices must still fall, that a lot of debt won’t be repaid and that most banks need significant equity injections by government. but the extent of this process is very unclear, because in truth many outcomes are possible.

by simply stating the problem clearly and addressing it in a credible way, the government will do more than anyone else can to minimise the current value destruction and achieve a better “equilibrium” outcome.

for this reason i much prefer soros’ suggestion of relying on impartial government technocrats to determine the true value of banks’ assets and therefore their capital needs. hardly a perfect solution, but in reality there is no perfect solution.

what it will achieve is a recognition that the problem exists and a credible solution that will do something to stabilise expectations about the direction of the economy. i would much rather have the “price discover” determined this way than leave it to a market mechanism in the middle of a financial rout.

If mark-to-market were temporarily relaxed to permit undercapitalized and insolvent banks to continue to operate while the Treasury’s recapitalization scheme is implemented, it would still be desirable to require banks to publish pro-forma statements for would-be investors that disclose assets valued at market value, since transparency for this purpose is essential to attract new private capital.

The US and UK (at least) banking system is all but surely insolvent _in aggregate_ given what they put their money in, what the prices of that what were, where the prices of that what are going, and what the background economy is going to be like concurrently for the duration of the going forth. I only but wish we would cull the zombie banks and shepherd those still whole to keep the national financial economy from stroking out.

Buiter’s much ballyhooed paper at Jackson Hole contains an extensive portion excoriating the Fed for using a risk-based approach to monetary policy during this catastrophe, calling such discussions of tail risk “jargon”.

It’s pretty obvious to even casual readers of his blog that he has abandoned that view.

In terms of the comments about math, keep in mind that G. Spencer Brown’s Laws of Form that Russell described as “resolving” his concerns about the Theory of Logical Types only took up about 40 pages, far less than Principia.

And Wittgenstein’s comments about the inverse relationship between the elegance of a descriptive system and the inelegance of its descriptive terms informs that discussion as well.

Matt Dubuque

The financial system, i.e. the banks, are insolvent.
Caused by, in case you haven’t noticed, a glut of debt thingies with 3 and 4 letter abbreviations.

For some reason, the solutions offered ALL involve pumping more debt, euphemistically described as capital, into the economic system?
The problem is too much debt, and the solution is even more debt.
The upside down pyramid of fractional-reserve banking is teetering.
While Hank and Ben figure new innovative ways to add more “weight” at the top.
And, thus, does not the doctor have the disease?

Isn’t there anyone out there listening long enough to see the benefits of the Chicago Plan solution?
And stop paying attention to the trees?

What is really needed is to separate out the banking function from the money-creation function.
Let the bankers lend their money, which is what everyone thinks they’re doing now.

Put the government in the proper role of creating the country’s new money.
The necessary infusion of capital should be debt-free, paid DIRECTLY to the American taxpayer on the full faith and credit of those taxpayers.
It’s time for trickle up economics.
Yes, the end of capitalism as we know it.
And the beginning of fair and honest capitalism and free enterprise.
Public credit.
Let’s get on with it.

a: “It took Russell and Whitehead a volume and a half and 600 pages.”

After the contributions to mathematics and finance by Matt Dubuque, it would only take 2 or 3 pages. Geniuses of his rank are rare.

It took Russell and Whitehead a volume and a half and 600 pages.