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Another interesting piece from Paul Krugman who by the way has just received the Nobel prize for economics.

By PAUL KRUGMAN
Has Gordon Brown, the British prime minister, saved the world financial system?

O.K., the question is premature � we still don�t know the exact shape of the planned financial rescues in Europe or for that matter the United States, let alone whether they�ll really work. What we do know, however, is that Mr. Brown and Alistair Darling, the chancellor of the Exchequer (equivalent to our Treasury secretary), have defined the character of the worldwide rescue effort, with other wealthy nations playing catch-up.

This is an unexpected turn of events. The British government is, after all, very much a junior partner when it comes to world economic affairs. It�s true that London is one of the world�s great financial centers, but the British economy is far smaller than the U.S. economy, and the Bank of England doesn�t have anything like the influence either of the Federal Reserve or of the European Central Bank. So you don�t expect to see Britain playing a leadership role.

But the Brown government has shown itself willing to think clearly about the financial crisis, and act quickly on its conclusions. And this combination of clarity and decisiveness hasn�t been matched by any other Western government, least of all our own.

What is the nature of the crisis? The details can be insanely complex, but the basics are fairly simple. The bursting of the housing bubble has led to large losses for anyone who bought assets backed by mortgage payments; these losses have left many financial institutions with too much debt and too little capital to provide the credit the economy needs; troubled financial institutions have tried to meet their debts and increase their capital by selling assets, but this has driven asset prices down, reducing their capital even further.

What can be done to stem the crisis? Aid to homeowners, though desirable, can�t prevent large losses on bad loans, and in any case will take effect too slowly to help in the current panic. The natural thing to do, then � and the solution adopted in many previous financial crises � is to deal with the problem of inadequate financial capital by having governments provide financial institutions with more capital in return for a share of ownership.

This sort of temporary part-nationalization, which is often referred to as an �equity injection,� is the crisis solution advocated by many economists � and sources told The Times that it was also the solution privately favored by Ben Bernanke, the Federal Reserve chairman.

But when Henry Paulson, the U.S. Treasury secretary, announced his plan for a $700 billion financial bailout, he rejected this obvious path, saying, �That�s what you do when you have failure.� Instead, he called for government purchases of toxic mortgage-backed securities, based on the theory that ... actually, it never was clear what his theory was.

Meanwhile, the British government went straight to the heart of the problem � and moved to address it with stunning speed. On Wednesday, Mr. Brown�s officials announced a plan for major equity injections into British banks, backed up by guarantees on bank debt that should get lending among banks, a crucial part of the financial mechanism, running again. And the first major commitment of funds will come on Monday � five days after the plan�s announcement.

At a special European summit meeting on Sunday, the major economies of continental Europe in effect declared themselves ready to follow Britain�s lead, injecting hundreds of billions of dollars into banks while guaranteeing their debts. And whaddya know, Mr. Paulson � after arguably wasting several precious weeks � has also reversed course, and now plans to buy equity stakes rather than bad mortgage securities (although he still seems to be moving with painful slowness).

As I said, we still don�t know whether these moves will work. But policy is, finally, being driven by a clear view of what needs to be done. Which raises the question, why did that clear view have to come from London rather than Washington?

It�s hard to avoid the sense that Mr. Paulson�s initial response was distorted by ideology. Remember, he works for an administration whose philosophy of government can be summed up as �private good, public bad,� which must have made it hard to face up to the need for partial government ownership of the financial sector.

I also wonder how much the Femafication of government under President Bush contributed to Mr. Paulson�s fumble. All across the executive branch, knowledgeable professionals have been driven out; there may not have been anyone left at Treasury with the stature and background to tell Mr. Paulson that he wasn�t making sense.

Luckily for the world economy, however, Gordon Brown and his officials are making sense. And they may have shown us the way through this crisis.

http://www.nytimes.com/2008/10/13/opinion/13krugman.html?hp
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[Ya-ta Boy]

[quote]whose philosophy of government can be summed up as �private good, public bad,�



Something tells me Henry Paulson is a Reaganite and Paul Krugman is not.

[mises]

Paulson is a Republican.

But here, and I suspect this will pull many of you into my anti-Hank corner, he is also a Randoid. As in, Ayn Rand, the libertarian Russian lady. He and Greenspan both.

[bangbayed]

[On the other hand]

[mises]

Well, I'm being a tad disingenuous.

Greenspan abandoned Rand a long time ago. He wrote a widely read (in Randoid circles) defense of the gold standard and assault on central fiat banking in her Capitalism, the Unknown Ideal. That didn't last long.

Paulson, as a Randoid, would never have taken the T-secretary position.

[On the other hand]

[mises]

Yeah, it is a collection of essays. It is in there. I read it many years ago now.

http://en.wikipedia.org/wiki/Capitalism:_The_Unknown_Ideal