Martin Wolf, drawing on the ideas of Andrew Haldane (Bank of England) and Adair Turner (chairman of the UK’s Financial Services Authority), provides his readers with yet another brilliant Wednesday column.
The combination of state [deposit] insurance (which protects creditors) with limited liability (which protects shareholders) creates a financial doomsday machine. …. Its most dangerous effect comes via the extremes of the credit cycle. Most perilous of all is the compulsion upon the authorities to blow another set of credit bubbles, to forestall the devastating impact of the implosion of the last ones. In the end, what happens to finance is not what matters most but what finance does to the wider economy. ….
Financial systems are important servants of the economy, but poor masters. A large part of the activity of the financial sector seems to be a machine to transfer income and wealth from outsiders to insiders, while increasing the fragility of the economy as a whole. Given the extent of the government-induced distortions in the system, even the fiercest free marketeer should accept this. ….
So what is to be done? ….
One idea, popular in US Republican circles, is: “just say no” to bail-outs. This is a delusion. Since financial institutions are powerfully interconnected, the government cannot credibly commit itself to not rescuing the system when in peril.
Another idea, popular among US liberals, is that the chief issue is “too big to fail”. …. Size matters. But it is certainly not all that matters.
A third notion is that … if only oversight had been effectively imposed, the pattern of overleveraging and default could have been halted. This, too, is unlikely. ….
In the end, halting the financial doomsday machine is going to involve fundamental changes in policy towards – and the structure of – the financial system. …. I plan to address that issue next week.
Martin Wolf, “The challenge of halting the financial doomsday machine”, Financial Times, 21 April 2010.
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[...] As promised, Martin Wolf this week looks at fundamental changes that might make the financial system more stable by reducing “the risk taken on by the gamblers working legally inside the machine”. He begins by looking at Canada. An obvious solution is to revert to a tightly regulated, oligopolistic banking system. This is the sort of system Canada has enjoyed. But it is stodgy. It is also inconsistent with globalisation. Access by residents to foreign finance and by domestic institutions to foreign risks makes such cartels inherently unstable. Martin Wolf, “Why cautious reform is the risky option”, Financial Times, 28 April 2010. [...]