Spread the pain

I'm getting a fair number of emails asking "Why not let the thing collapse all at once instead of dragging it out? Wouldn't it be better to get it over with? Plus, no moral hazard!"

How do I say this? No. NO!. Excuse me, but the Austrian "work the rot out of the system" arguments make me a bit touchy.

The Great Depression is a good example of what happens when the government stands by while credit markets collapse. Oh, don't get me wrong, the government did plenty of affirmative bad things to prolong and deepen it, starting with Hoover's lunatic tax increase and defense of the gold standard, and moving steadily on to FDR's various insane attempts to rig prices, which only halted when some senators explained that no, they didn't really fancy giving the executive branch quasi-dictatorial powers, no matter how nice a chap FDR happened to be. But the credit contraction triggered by the stock market collapse is what got the ball rolling.

Financial markets are strange creatures. They are uniquely prone to turn negative expectations into self-fulfilling prophecies: if everyone thinks that your bank is going to collapse, it will, even if its financials are perfectly sound. When banks collapse and depositors lose all their money, not only do real people get hurt, but also the ripple effect does very, very unkind things to GDP.

Asking whether it wouldn't be better to get it all over with at once is like saying "I hate having to take my statins every day--why don't I just take all thirty pills this morning?"

For an explanation of how a lack of liquidity can crush the economy, you can't do better than Paul Krugman's old piece from 1998.