On the trail of the real root cause

Submitted By Tim Iacono
Having long thought that Fed Chairman Ben Bernanke is an exceptionally bright fellow and an excellent writer (if not the best economic forecaster, as seems to be the rule rather than the exception - perhaps even a prerequisite - for someone to have risen so far in his field), his choice of words in today's Wall Street Journal op-ed piece regarding the "root" of the current financial crisis is worthy of note.

The Fed Chief strikes much closer than most to the real root cause of the current problems in noting that it is "a loss of confidence by investors and the public" that has brought us to where we are today, requiring global interventions on a scale never before seen in history with a positive outcome that is still, by no means, assured.

While a huge improvement over the blather about "falling home prices" being at the head of the causal chain, after just a bit of contemplation, "loss of confidence" also seems to fall short of the mark.

Here it is:

We're Laying the Groundwork for Recovery
The necessary policy tools are in place.
By BEN S. BERNANKE

As Americans well know, the challenges we now face in the financial markets and in the economy are both extraordinarily complex and historic in scope. I firmly believe, however, that with the actions policy makers are announcing today, we will be able to meet those challenges.

Our strategy will continue to evolve and be refined, and we will adapt to new developments and the inevitable setbacks. But we will not stand down until we have achieved our goals of repairing and reforming our financial system, and thereby restoring prosperity to our economy.
...
As in all past crises, at the root of the problem is a loss of confidence by investors and the public in the strength of key financial institutions and markets. This has had cascading and unwelcome effects on credit availability for households and businesses, and on the value of savings. Under these circumstances, steps to restore confidence in our institutions and markets will go far toward resolving the current market stress. Our economy will not be able to function at its best unless and until financial market stability returns. The bold actions taken by the Congress, the Treasury, the Federal Reserve, the Federal Deposit Insurance Corporation and other agencies, together with the normal recuperative powers of the financial markets, will lay the groundwork for financial and economic recovery.
...
I am not suggesting the way forward will be easy. But the tools are in place to respond effectively and with force. These tools will bolster the capital of our financial institutions, restore confidence in their debt, and offer increased access to funding for businesses. Their application, together with the underlying power and resilience of the American economy, will help to restore confidence to our financial system and place our economy back on a path to vigorous growth.

Presumably, if this loss of confidence in financial markets is justified - not just a frightful episode that will soon pass - by the growing understanding that the business model under which the system had previously operated was fundamentally flawed (i.e., that we can't all get rich through rising asset prices - at least not for a long enough time), then, perhaps this "loss of confidence" really isn't the root cause.

Stock prices go up and then when you think they can't go up anymore they go even higher and we all feel rich until they come crashing down.

After the last five or six years, the same can be said about real estate.

Why should investors and the public have any confidence in a financial system that has produced the vanishing wealth of the last decade?

It would have been better to have never been seduced by this wealth at all.

Loss of confidence is not the root cause here.

Loss of confidence is a very rational reaction to the growing realization that the financial system that has been in place for many, many years has fundamental flaws that are in dire need of remedy, a task that seems to get all too little attention as bigger and bigger checks are written in an attempt to preserve the status quo.

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