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The Government-Created Moral Hazard Was There Even Before 1999

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I just reviewed U.C.L.A. economist Roger Farmer’s new book How the Economy Works [2].  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].