Financial Market Reform - Reason Magazine - The Diigo Meta page

• 05 Nov 09
  

  Eric Hanneken

  finance crisis regulation moral hazard government politics Jeffrey Miron

  • According to perceived wisdom, the root cause
    of the 2008 financial crisis was excessive risk-taking, and
    proper regulation can detect and prevent such excess in the
    future.

  • The Financial Crisis of 2008 did not occur because of
    insufficient or ill-designed regulation. Rather, it resulted from
    two misguided government policies.
    

    
    
    

    
    The first was the attempt to promote homeownership.

  • 7 more annotations...
  • • The pressure to expand risky credit was especially problematic
      because of the second misguided policy, the long-standing
      practice of bailing out failures from private risk-taking. This
      practice meant that financial markets expected the government to
      cushion any losses from a crash in mortgage debt. Thus, the
      historical tendency to bail out creditors created an enormous
      moral hazard.
    • any mistakes made by a powerful,
      centralized authority have a magnified impact because they
      distort the behavior of the entire market.
    • under the proposed system, bank holding
      companies would forever more regard themselves as explicitly, not
      just implicitly, backstopped by the full faith and credit of the
      U.S. Treasury. That is moral hazard in the extreme, and it will
      create an unprecedented incentive for excessive risk-taking by
      these institutions.
    • The only way to limit financial panics is to eliminate
      government-induced moral hazard, and that means letting failed
      institutions fail.
    • Rather than being a cause, Lehman’s failure was merely the signal
      that time had come for the U.S. economy to pay the price for all
      the distortions caused by the misguided policies toward housing
      and risk. Given those distortions, a massive unwinding and
      restructuring was necessary to make the economy healthy again.
    • The announcement that the Treasury was considering a
      bailout scared markets and froze credit because bankers did not
      want to realize their losses if government was going to bail them
      out. The bailout introduced uncertainty because no one knew what
      the bailout meant.
    • The third and perhaps most important way to reduce moral hazard
      is to eliminate the Federal Reserve. As long as the Fed exists,
      it will regard itself as, and be regarded as, the economic
      insurer of last resort.

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