So the US government finally wants to monitor systemic risk, after being whacked between the eyes? Perhaps they should ask who creates systemic risk? Who runs the system? Well, they do. The US Government, together with the Federal Reserve, have so much power that their decisions influence the system as a whole.
Dropping the Fed funds rate to 1% during 2003 helped drive systemic risk as they encouraged Americans to lever up and buy real estate. The Greenspan era was an exercise in providing liquidity beyond what was normally needed. Because of the demographics, more savers than spenders, the excess money inflated assets, not goods. People don’t complain when assets inflate and goods deflate. It is quite the reverse when goods inflate and assets deflate.
By running countercyclical policies, the Government/Fed trains the markets to realize that the Government/Fed has their back, and that they don’t have to worry about taking too much risk. There is the systemic risk. Risk can never be eliminated from the economy as a whole. To the extent that the Government moderates/absorbs/subsidizes the risks, the private sector gets more aggressive, raising the total risk level.
The US Government hasn’t done a great job managing the economy. Why should we entrust them with the tougher task of managing systemic risk? Oddly, managing systemic risk is easier if it was not managed. If there is no one there to protect you, what do you do to avoid malign swings in the economy? What’s that? Save more and grow slower? Yes. Don’t play it to the limit.
To guard against systemic risk, we would need a government over the US Government constraining its actions, preventing its procyclical policies, which are politically popular. There is no entity that can be that, particularly not the UN (useless nations). They have the same problems and worse.
Go ahead, let the US government try to eliminate systemic risk. They will quickly find that politics favors concentrated special interests that petition the government to increase systemic risk during boom times, leaving the economy to flounder during the bust times.
The Government can’t fight itself.
Isn’t monitoring systemic risk essentially what the Fed is supposed to be doing now–engaging in counter-cyclical policies? Isn’t that why it is “independent” and not subject to political pressure, at least in theory? We need a Fed chairman who doesn’t mind being hated–and all we have gotten since Volcker is one who wants to be loved.
This is what all bureaucracies do–when one department fails to fulfill its mission, another one is created to oversee it. Ecrasez l’infame!!!
This economic dislocation was the free market attempting to reduce systemic risk. System risk comes from too-big-to fails (both private and public institutions). Several of the big banks would have failed. Smaller, more dynamic, better-managed banks would have taken over the assets at prices that would result in an economic profit, and the investors who capitalized these banks would have experienced one of the probabilistic outcomes of investing in risky assets (i.e., loss of principal). Risk would have been decentralized.
Similarly, having a gigantic government presents a systemic risk. The tenth ammendment was ratified with the Constitution, notably to define the scope of government. A lot of people don’t seem to get it — ignoring the 10th ammendment has created the mother of all system risk–the Federal government. It’s such a systemic risk that it creates a global systemic risk. Imagine if decentralization occured, as the 10th ammendment mandates…
It makes perfect sense to diversify power much like one diversifies to mean-variance optimize an investment portfolio. If a State has a horrible system of governance/economic policy, the scope of the problems caused by that State will be much smaller than centralizing economic planning at the Federal level where, if policy is misguided (e.g., the contemporary economic paradigm is wrong), the entire system is subject to the same error.
PS: I should note that I am not of the camp that believes letting the big banks fail would be without consequences. We have a capital markets system that relies heavily on the primary dealers and mega-banks for capital market liquidity. Surely, it would take time for a decentralized system to replace what is in place now.
The point is that it would be healthy, if we were willing to adjust instead of kick the can down the road.
That’s why AIG did such a great job right, no one to protect them?
Is the Fed the government? It is and it isn’t.
Everybody wanted easy credit and easy money. I blame the Fed as much as anyone possibly could but they were just playing the part given to them in the great drama.
Fed-Government-the Governed, it’s all chicken and egg stuff to me. Besides, nothing has really happened yet.