Wednesday, July 7, 2010

The discussion Congress should be having: PART 2, Whose ox did we gore?

Where are the start ups?

US NEWS AND WORLD REPORT made an interesting comment in a piece on financial regulatory financial reform (“4 Things Financial Reform Won’t Do For You - Rick Newman (” ). The relevant section is quoted below. It lists one of the things the legislation won’t do as:

“Come up with creative financing. While clamping down on risky lending, banks and their government overseers have also denied credit to many who legitimately need it. Scarce credit is especially hard on small-business owners, who often use bank loans or credit cards to pay suppliers or stay current on rent. The stranglehold on small business is one reason hiring is weak and the whole economy is fragile, because small business accounts for an outsized portion of new jobs. The government thought it would solve this problem by bailing out the banks, which in turn would inject more money into the economy, but it hasn't worked out that way so far. So, many people who desperately need credit have had to tap friends or family, mortgage assets, hastily improve their creditworthiness and find unconventional sources of money.”

This may sound a bit familiar to anyone who read “The Hedged Economist: Angels, entrepreneurs, and diversification: PART 1.” It pointed out the importance of family, friends, mortgages, and credit. But, it also argued that other sources of capital are essential. My contention is that by making the environment hostile to start ups and self employment, the entire economic food chain is given stomach cramps. Nothing makes the environment more hostile than choking off credit.

But, it is worth noting that the problem isn’t just financial reform. This blog pointed out back in March in “The Hedged Economist: Regulatory capital and who’s got the money?” that for bank stability and ultimately economic stability “Increased capital is ultimately the solution. But, timing changes is probably more important than the level. What we know about reserves is that people lower them in good times and raise them in bad times. We also know this aggravates the cycle. Well, surprise, surprise, governments are people; they do the same thing. Unfortunately, the government has a long history of changing capital requirements in the wrong direction over the business cycle. It’s the fallacy of composition writ large. Individual banks are safer with higher reserves, but if every bank raises more capital, oops, no credit even for productive endeavors.” So, regulatory reform is just aggravating a bad situation.

So, while the IPO market has problems of its own, one should never underestimate the importance of the general economy. “General economy” is a nice way to say “how people get by.” Make getting by dependent on government and sooner or later government runs out of rabbits in its hat. Further, governments, and for that matter, the media have problems with amorphous, self-contradictory, disorganized (maybe self-organizing) bunches of people. If amorphous, self-contradictory, disorganized or self-organizing doesn’t sound like how people get by, go out and talk to you neighbors, friends, relatives, and be sure to include some strangers.

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