Thursday, October 31, 2013

What should we do during the next financial crisis?

NY Times interview with Nobel Laureate Gene Fama:

In the financial crisis, do you think the government should have bailed out the big banks?
No, I don’t. I would’ve favored nationalizing the banks, not bailing them out.

Really? That’s not very libertarian, is it?
Well, we’re talking about realistic alternatives. It’s not credible that in a financial crisis, the government will do nothing. It never has. There are going to be demands for it to do something. So you’ve got two choices now. Nationalize them or bail them out. Bailing them out gives them terrible disincentives; it encourages them to take risks because they’ll be bailed out. So I’d nationalize them — and clean them up and then reprivatize them.

HT:  Merle Hazard


  1. Interesting thought, but does nationalizing the bank, cleaning them up then reprivatizing them really discourage risk-taking? Seems like there still is a "safety net" in that regard.

    1. Just do not make those senior managers think that they are safe -- when the banks get nationalized, they shall lose their compensation and pension! Sounds terrible to be a banker, now I am going to worry whether there are somebody bold enough to lead a bank!

  2. You could have nationalized the banks and republicized them later but I am not sure how confident I am in the government running anything these days.

  3. Very uncharacteristic of Froeb to favor nationalizing anything, but it's a logical argument. My only two concerns are one, if the government has enough information about how to run a bank. Two, the government turned an asset to high valued use by buying the bank stocks at such a low price and selling them back later. Would the it have made the same return if it had nationalized the banks?

  4. The problem of moral hazard with bailouts is that they are like insurance. The financial institutions, such as the giant banks that are “too-big-to-fail” ought to be increasingly monitored the more systemically influential they are to the economy. The cost of the entire economy being dragged under with them because of their risky sub-prime mortgage bets was obviously catastrophic. “Borrowers take bigger risks with other people’s money than they would with their own (Froeb, 2014:238).” The incentive to take bigger and highly leveraged bets on risky assets with borrowed money is too tempting. The incentive of mortgage originators was to make and sell as many loans to increase profits and investment banks gladly securitized them and passed them on to investors that thought they were a safe investment. In addition to Frank-Dodd, maybe the Glass-Steagall Act should also be brought back to keep commercial and investment banks separate and help prevent the next financial crisis.

    Froeb, McCann, Ward, Shor: (2014) Managerial Economics. A Problem Solving Approach,
    Ohio: South Western Cengage Learning