up to our tits in debt

what happened to the mortgages? in the wake of lehman brothers' failure, i distinctly remember the federal reserve boldly announcing that it would put balls to bones buying up all of the bad decisions which finance had so gleefully made. it then almost instantaneously changed its mind, partly due to pressure from congress and, i suspect, most especially because of pressure from industry; the plan became to recapitalize the banks to prevent the termination of credit services. as tim harford over at the ft says, while recapitalization was probably not a bad idea, leaving those securities floundering in null space will not help rid us of them. the reason why those asset-packages have been so buzzingly described as 'toxic' is because the price that they sold for hid, because of the byzantine mathematics used to value them, what they should really have fetched. in other words, they lacked a real price, and for the market to reabsorb them that hurdle has to be jumped.

there are, of course, a few difficulties:

Holding a single auction with a single price would be a disaster: only the most worthless assets would have been offered for sale ... But simply holding many different auctions is not much better. Once finished, a bank might be surprised by the prices, wishing it had sold more of one kind of asset at a generous price, and fewer of its others. Not only would the banks have acted differently with hindsight, but the Treasury would want them to, in the interests of higher revenue and more price transparency.

some theories have been proposed for a dynamic auction-structure, one in which banks are able to alter their bids based on those of their competitors (in other words, to create a short-lived mini-market for the securities). even this plan has one enormous problem: it will have to be carried out in real time, while financial markets are open, and, given the sheer amount of money involved, will assuredly cause a feedback loop between the auction and the exchanges. you can bet that the boys over at the chicago board of trade would have a futures game going faster than the street could get paulson to pay citibank's december bonus bill. inevitably, markets would value the securities internally, thus forcing banks to bid downwards, markets to respond, and the whole thing spiralling quite clearly out of the fed's control. in the end, we'd be no closer to getting clear price signals than before.

still, we need to know the real extent of the damage that those bubble-era liabilities pose to us. we could simply wait for finance to get its legs back under it, at which point it might (with taxpayer handholding, natch-relly) feel up to the challenge of cleaning up the shit it took on the carpet. 'time' is, here, an indeterminate quantity, of course; and, further, there is no guarantee that economic progress is proportional to the temporal kind at a one-to-one rate. deflation is sure to squeeze credit markets further (though there are very, very tentative signs that lending is resuming), for one thing. (1+i)(P/P^e) (where i is the current interest rate, P is the current price level and P^e is the expected future price) predicts, in the case of money, that, with the fed funds rate bottomed out and P^e sticky, the only loosening of the supply of money can come from a fall in P. obviously, money must be very expensive for lending to be at a standstill, and therefore the money supply must still be contracted. until money is cheap--until we have new capital supplies--i don't see why finance would be interested in the equivalent of buying broken televisions from a just-napalmed target. the conclusion? gentleman, start your bidding.