From the Richmond Fed:
• A contributing factor to the financial crisis of 2007-08 was the government's long history of emergency loans to distressed institutions and markets deemed "too big to fail." This history has created an expectation that certain parts of the financial sector will be protected from losses.
• This government safety net effectively subsidizes risk-taking. Investors that feel protected by the government will be less likely to demand higher yields as compensation for risk, and creditors will feel less urgency to monitor firms that are implicitly protected.
• Excessive risk-taking makes firms more likely to experience distress and require bailouts to remain solvent. Additional bailouts can then further erode market discipline.
• This self-reinforcing cycle suggests that the safety net will grow ever larger over time. The safety net has increased by one-third since the Richmond Fed's first estimate in 1999. It covered 60 percent of financial sector liabilities as of 2013.
• Resolution plans, or "living wills," could be an important tool for establishing credibility against bailouts by making the government safety net the less attractive option in a crisis.
Nice points. Very good and meaningful.
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ReplyDeleteWhen the government guarantees over half of the financial sector’s liabilities, it indirectly encourages greater risk taking which could be a rewarding or grossly irresponsible gamble for the financial institution. With the safety net provided by the government, institutions would have less oversight in how they trade and would mean that they would indirectly gamble with tax payer’s money. Finance is not my strong suit, but a system should be implemented where banks either have cash or gold reserves which they must maintain in order to stay in business. In my opinion, a government safety net does not promote responsibility in the financial sector and only gives the banks the freedom to gamble more.
ReplyDeleteWhen the government guarantees over half of the financial sector’s liabilities, it indirectly encourages greater risk taking which could be a rewarding or grossly irresponsible gamble for the financial institution. With the safety net provided by the government, institutions would have less oversight in how they trade and would mean that they would indirectly gamble with tax payer’s money. Finance is not my strong suit, but a system should be implemented where banks either have cash or gold reserves which they must maintain in order to stay in business. In my opinion, a government safety net does not promote responsibility in the financial sector and only gives the banks the freedom to gamble more.
ReplyDelete