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David Leonhardt [2] (HT: Arnold Kling [3]) finds a fascinating paper by Akerlof and Romer [4] from 1994 called "Looting." It's an analysis of the moral hazard problem that results when too many financial institutions are considered too big too fail. I will read the original article but in the meanwhile, Leonhardt's summary is well worth reading and consistent with Allan Meltzer's claim [5] (start listening around the 42 minute mark). One highlight from Leonhardt:
Promised
bailouts mean that anyone lending money to Wall Street â ranging from
small-time savers like you and me to the Chinese government â doesnât
have to worry about losing that money. The United States Treasury [6] (which, in the end, is also you and me) will cover the losses. In fact, it has to cover the losses, to prevent a cascade of worldwide losses and panic that would make todayâs crisis look tame.
But
the knowledge among lenders that their money will ultimately be
returned, no matter what, clearly brings a terrible downside. It keeps
the lenders from asking tough questions about how their money is being
used. Looters â savings and loans [7] and Texas developers in the 1980s; the American International Group [8], Citigroup [9], Fannie Mae [10] and the rest in this decade â can then act as if their future losses are indeed somebody elseâs problem.
Do you remember the mea culpa that Alan Greenspan [11], Mr. Bernankeâs predecessor, delivered [12]
on Capitol Hill last fall? He said that he was âin a state of shocked
disbeliefâ that âthe self-interestâ of Wall Street bankers hadnât
prevented this mess.
explains why his laissez-faire theory didnât hold up. The bankers were
acting in their self-interest, after all.