Is the Crisis Real?

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September 26, 2008 6:28 p.m.

At a Harvard panel discussion yesterday, economics 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 demanded. 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?

Ken also talked about the need to shrink the financial services sector. He thinks it is good that the investment banking houses are failing and many people on Wall Street are losing their jobs because, in his view, we have an oversupply in that sector and our economy just can’t support it.

Ken’s background with the IMF and on the Board of the Federal Reserve add a certain credibility to his assessment of conditions on Wall Street. If he is right, the $700 bailout is saving some investment bankers’ jobs in the short term, but overall it is making the financial system worse.

It was a terrific panel: Nobel winner Robert Merton, Dean of the Harvard Business School Jay Light, Harvard economist and Chair of the President’s Council of Economic Advisers-2003-05 Greg Mankiw, Harvard Business School Prof and long-time Goldman Sachs partner Robert Kaplan, and me. It might be worth listening to the webcast.

If you tune in, don’t miss Ken’s talk (he is fifth of the six of us). He is calm and funny, but there is no too-big-to-fail talk. Instead, he makes the whole rush-to-bailout look like a very bad idea.

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