Friday, December 28, 2007

Bank Run!

At LRB John Lancaster has a very good run down of the sub-prime mortgage crisis, the Northern Rock debacle and the trouble with derivatives. The prognosis? no one knows yet. Things may be ok; they may also end up very messy.

How messy? Will Hutton advises us that at least one central banker intends to spend his Christmas holiday reading The Great Crash.

Central Bankers haven't just been reading either: plans are already being enacted to - hopefully - stave off a credit crunch and cascading collapses. The scary thing is that there is no guarantee that they will work.

At a slightly more abstract level, the thought of governments riding to the rescue has Matt of TVHE worrying about moral hazard: if state institutions keep bailing out investors when they get it wrong, won't this simply encourage more risky behaviour in the future?

Personally, I'm worried about a different moral issue: fairness. When things go right financial institutions profit handsomely. When they go wrong tax payers foot the bill. Profit is privatised, risk is socialised. It's a great example of markets and the state colluding to keep the wealthy wealthy.

And yet, if central banks don't intervene the ensuing collapse will hurt the poor more then the prosperous, the innocent as much as the guilty. All those people who had their life savings in Northern Rock did nothing wrong. Do we really want to punish them?

The dilemma is a real but it also has a potential solution: regulate financial markets much more aggressively in the first place. If you we did this, then we might find ourselves juggling unpleasant options on the edge of cliffs slightly less often.

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