More radical approaches – allowing more banks to default, for example – would have increased uncertainty in the short run and so undermined the return to stability Mr Obama craves. But here the president must reckon on a longer-term danger: that the rescued financial system will, in time, start to lay the foundations for another and possibly still bigger financial crisis in the years ahead.
Ensuring the rescue of a financial system packed even more than before with complex and “too-big-to-fail” institutions may well be the cautious response to this crisis. But it leaves the government with the even more onerous task of imposing effective regulation in future. Unhappily, the record of regulation of generously insured financial systems is extremely poor. The mobilised self-interest of highly rewarded players easily overwhelms the constraints imposed by far less well-rewarded and almost certainly less able regulators.
The more the crisis unfolds, the more evident it is that incentives in the financial system were (and are) badly distorted. I sympathise with the conservative approach to crises, but not if it leaves in place the plethora of perverse incentives that created them. At the end of this, then, there will be one big test: will the number of institutions thought “too big to fail” be as large as now and, if so, how will they be controlled? If the answers are still not clear, there will need to be yet more change.
http://www.ft.com/cms/s/0/5e7dd89c-3f1c-11de-ae4f-00144feabdc0.html?nclick_check=1
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