There are two related aspects to the crisis besetting financial institutions which are now shrinking their balance sheets by cutting credit to the economy: (1) the illiquidity and falling value of some of their assets, and (2) a shortage of capital, as only 70% of the recognised losses have so far been matched by new capital. Second, however, once the Treasury and the Fed have jointly announced their emergency program, with the stark motivation that it is the only way to avoid an imminent meltdown, doing nothing or unduly delaying its implementation would increase uncertainty and plunge the markets into chaos. An earlier pre-emptive move (a solution similar to TARP was proposed in the Financial Times in April and in Vox and in CEPR Policy Insights in May) may have prevented the acceleration of the vicious feedback between the falling value of the assets of financial institutions and their capital and funding requirements. First, its effectiveness is impaired by coming too late, as a hastily defined measure of last resort after the crisis has become acute. Two preliminary remarks on the timing of the TARP initiative (or, for that matter, of any other proposal as bold and sizeable as TARP).
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