Thursday, July 2, 2009

The Danger of Incentives for Bankers to Take Risks with Taxpayer Dollers: Martin Wolf Gets It, Larry Summers Doesn't.

Martin Wolf of the Financial Times said flat out yesterday that the inadequate reforms of the U. S. financial system coming from Summers & Co are certain to lead to a second financial crisis. His main concern? Incentives: the incentives that Summer & Co. have given America's "too-big-to-fail" bankers to take risks with taxpayer dollars. Links to three recent Martin Wolf columns are here, here and here. The first is the most outspoken and urgent. It opens with a warning.
With one bound the banks are free, or so it seems. Already, the panic of the autumn of 2008 is fading. The period within which lessons can be learnt and changes made is closing. Yet without radical changes, another crisis is certain. It may not even be that long delayed.

He goes on to say of the Summers reforms that
what has emerged after the crisis is . . . an even worse financial system than the one with which we began. The survivors are an oligopoly of “too-big-and-interconnected-to-fail” financial behemoths. They are the winners not because they are necessarily the best businesses, but because they are the best supported. It takes no imagination to realize what these institutions might now do, given the incentives for risk-taking.
Wolf has three remedies for this state of affairs: capitialization, liquidity and incentives. He deserves close attention. He is the most widely respected financial writer in the world. And it's amazing how no one of our side of the pond seems to be listening to him. One exception is finance blogger Yves Smith at Naked Capitalism who says that
Wolf understands the problem, but only alludes to the implications. It is now abundantly clear, to use that Richard Nixon turn of phrase, that the big banks not only have a license to steal, but the goverment now undermines its risks. That plus the failure to try to engineer controlled deleverging (high leverage is systemically destablizing) guarantees that if we do not sink into Japan-style maliase, we will have an even bigger crisis in pretty short order, five years at the very outside. The failure to implement real reforms will cost us dearly, and sooner than anyone wants to believe.
If you can stomach this, take a look at the latest column from Mike Whitney.

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