The Government-Created Moral Hazard Was There Even Before 1999

by Don Boudreaux on August 13, 2010

in Books, Financial Markets, Frenetic Fiddling, History, Intervention, Man of System, Myths and Fallacies, Regulation, The Crisis

I just reviewed U.C.L.A. economist Roger Farmer’s new book How the Economy Works.  I’ll wait until my review is published before revealing my opinion of the book and of his proposal – well, okay, just a peak: I believe his proposal (namely, that central banks also target broad stock-price indices in order to manage economy-wide “confidence”) to be both impractical and very dangerous.

But the book has several good features (amidst several bad ones).  Here’s one of Farmer’s sound observations:

There are two main criticisms of the regulatory changes that occurred in the 1990s.  The first is that the repeal of the Glass-Steagall separation of commercial and investment banking led commercial banks to take unnecessary risks with depositors’ funds.  This overstates the case.  The   repeal of Glass-Steagall simply codified an implicit guarantee that had been there all along.

During the 1987 financial crisis, it was the investment banks that were in trouble – not the commercial banks – and at the time, the Glass-Steagall Act was still in place.  Nevertheless, Alan Greenspan, implicitly or explicitly, channeled cash to the investment banks to prevent their collapse [p. 133].

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