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The Government-Created Moral Hazard Was There Even Before 1999

Posted By Don Boudreaux On August 13, 2010 @ 12:22 pm In Books,Financial Markets,Frenetic Fiddling,History,Intervention,Man of System,Myths and Fallacies,Regulation,The Crisis | Comments Disabled

I just reviewed U.C.L.A. economist Roger Farmer’s new book How the Economy Works [1].  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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[1] How the Economy Works: http://www.amazon.com/How-Economy-Works-Confidence-Self-Fulfilling/dp/0195397916/ref=sr_1_1?s=books&ie=UTF8&qid=1281716426&sr=1-1

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