Felix Salmon Channels Tim Geithner

Felix Salmon has certainly matured into one of our most helpful and generally instructive commentators on the mare's nest that is modern finance.  Such a surprise, then, to hear him utter flapdoodle like this:

Balance sheets have two sides, of course: assets and liabilities. And I suspect that what Mark might have in mind here is attacking the liability side of things, through pushing principal reduction on mortgages or allowing them to be reduced in bankruptcy.

But there’s a problem with trying to reduce liabilities: when the markets lose faith in credit instruments, as we saw during the crisis, the repercussions can reverberate around all markets and all countries. So governments around the world made a conscious decision to keep most bondholders whole, while injecting new capital and diluting equity holders in their attempt to shore up balance sheets.

Say wha--?  So we want a universal put  under all senior claims?  Do what you will as long as the bondholders don't feel any pain?   "Markets [might] lose faith in credit instruments."  Felix, baby: this is exactly what we want.  We want markets to pay attention to what kind of credit they are underwriting, and not buy crap--or at least, not unless they can get it at Matterhorn prices, such that they can expect to cover their own losses.  Or, if the problem is "interconnectedness," so they will do a lot to try to police the system against a fatal meltdown.  


Instead, we live in a world of "let Tim do it," where the lenders can take any kind of risk no matter how ill-considered because they know the guy with the briefcase shackled to his wrist will move mountains (= mountains of taxpayer money) to make sure they don't suffer the consequences of their own folly.

I admit that housing (of which Felix was writing when he made this uncommonly silly remark) might be a somewhat special case, in that most of the attention has been focused on keeping debtors in the homes they so improvidently purchased: a more hairy-chested market solution would recognize that some foreclosures are going to happen.  But in general: senior does not mean "don't worry, the taxpayers will pay."  Senior just means you are above the Plimsoll line.  The ship can still sink.