In normal times, our models predict, with the ability to diversify portfolios that exists today the risk discount on assets like corporate equities should be around 1% per year. It is more like 5% per year in normal times -- it is more like 10% per year today.
Read the whole thing. I give Brad a lot of credit for steering clear of IS-LM analysis and trying to re-think macro from the ground up.
In my important 9th lecture on macroeconomics, I said that the financial sector tries to hold long-term, risky assets and issue short-term, risk-free liabilities. What has been going on this year is a massive reversal of that. Financial institutions are fighting and clawing with one another to shed long-term, risky assets and instead acquire short-term, risk-free assets. The financial sector has become dysfunctional in a really major way.
The trick is to right-size the financial sector while slowing down the pace of de-leveraging. In my opinion, the bailouts and rescues are not helping with either process.