Friday, October 17, 2008

Do Paulson and Bernanke Watch "House"?

I doubt Mr. Paulson and Mr. Bernanke have time to enjoy prime-time TV. Too bad, because their economic interventions are starting to resemble an extended episode of House, minus the snappy dialogue.

For those of you who don’t watch the show, Dr. House is this brilliant but misanthropic guy who diagnoses mysterious life-threatening ailments using a reckless trial and error process. In the first third of the show he typically kills the patient, who then gets revived with those jumper cable thingies. Then he pumps the victim full of powerful meds, bringing on internal bleeding, liver failure and/or a brain aneurysm. This somehow helps House to figure out what's wrong and, after more jumper cables, to find a successful treatment that usually involves drilling a hole in the patient’s skull without anesthesia.

You can pretty much count on the fact that, 2/3 of the way through each episode, the patient will be on life support and no one will have any idea which symptoms come from the underlying disease and which come from House’s ministrations.

With the economy in critical condition, Bernanke and Paulson have administered, all at once, a barrage of drastic and experimental treatments. It’s too soon to tell if these moves have been wise, though you have to admit they’ve been gutsy. But as this article in yesterday’s WSJ points out, the cure and the disease are starting to merge.

The authors, Liz Rappaport and Serena Ng, give a bunch of examples of how government intervention is skewing markets. For example, the spread on Fannie bonds has risen because money managers are drawn to bank debt, with its shiny new FDIC guarantee. The commercial paper market is discombobulated because there are different backstops for different products. And looking forward, the cost of the bailout (and Barry Ritholtz points out that it's way beyond $700 billion) will force the government to issue more debt, raising yields on Treasuries. This will probably drive up mortgage rates, which could further slow the pulse rate of the housing market.

Let's hope the Federal Reserve has stocked up on jumper cables.

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