Blog on the Run: Reloaded

Friday, October 16, 2009 8:25 pm

What we’ve learned from recent economic events

Short version: not bloody much if, by “we,” you mean “The Cato Institute.”

Now, I actually concur with the writer’s assertion that government did, in fact, play a central role in creating the current disaster. Greenspan held interest rates too low too long, creating the credit bubble, for example.

The writer also asserts that lots and lots of financial laws and rules and regulations have been created to prevent this sort of thing and that none of them worked, and that this problem has gotten as big as it has precisely because of government action. And to a large extent he’s right about both the problem and the solution.

To a large extent — with one huge exception. See if you can spot it:

No regulation has had as great an effect on the risk-taking of the banking sector than the lifeguard role of central banks (and now finance ministries, as well). This has taught the major financial players to take hair-raising risks in the knowledge that they can privatize any gains and socialize any losses because they are too big to fail. The dilemma, however, is that they would never have grown so big if they had not had that safety net. Present-day capitalism is sometimes attacked for being nothing more than a “casino economy.” But I know of no casino where the head of a central bank and the finance minister accompany customers to the roulette table, kindly offering to cover any losses.

The problem is, we do not have a casino economy. To borrow a metaphor from child rearing, we have a “helicopter economy.” Helicopter parents hover over their kids, preventing them falling and hurting themselves. This means their children never grow up and learn to see dangers for themselves. And for this very reason, such children will eventually fall in more serious and dangerous contexts instead, because risk is part of the human condition. The helicopter economy works in a similar way. The government hovers over the banks and investors, making sure they do not get hurt too badly (and cleaning up any messes they leave behind.) Whenever there is an accident, the benchmark rate is lowered, the central bank extends credit and taxpayers’ money is pumped in. The players never learn to look out for risks; they just continue their reckless behaviour, and sooner or later they will fall off a ledge that they were not watching out for and pull us all down with them.

Capitalism without bankruptcy is like Christianity without hell — it loses its ability to motivate humans to be prudent or respect their fears. If completely removing the safety net from under the financial market is not politically feasible, then it is necessary to make a division so that they protect only pared-down banks engaging in simple operations. All other financial institutions should be told in no uncertain terms that the government’s only responsibility to them, if they fail, is to wish them luck.

Found it yet?

Read those last two sentences again, particularly the first of the two.

“Make a division so that [the safety net protects] only pared-down banks engaging in simple operations.”

What a great idea! Why hasn’t someone thought of that before?

Oh. Wait. Someone did. And it worked great for 67 years.

And then we repealed it. And it took the markets less than a decade to do exactly what the repealed law would have prevented.

This was huge. And the writer pretends it never happened. Amazing. Apparently I’ve learned more from recent economic events than the Cato Institute.


1 Comment

  1. […] us both into and out of the ‘81-’82 recession, thinks we need to kind of restore the Glass-Steagall Act, which kept commercial banks from doing investments (and being dragged under when those investments […]

    Pingback by More odds and ends « Blog on the Run: Reloaded — Wednesday, October 21, 2009 10:48 pm @ 10:48 pm

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