On 5/15/05, sam gindin <[EMAIL PROTECTED]> wrote: > Yes. To some degree a major rescue does create 'moral hazard'. But the Fed > will obviosuly do this only in a rare emergency case and make it clear that > it will be an exception - as has happened in the past with some increase > perhaps in speculation but not a debilitating increase... >
--------------------- <http://www.federalreserve.gov/boarddocs/speeches/1997/19970429.htm> Remarks by Chairman Alan Greenspan G-7 economic summit meeting At the Spring Meeting of the Institute of International Finance, Washington, D.C. April 29, 1997 "Regulation by government unavoidably involves some element of perverse incentives, that is, moral hazard. If private market participants believe that government is protecting their interests, their own efforts to do so will diminish...With leveraging there will always exist a remote possibility of a chain reaction, a cascading sequence of defaults that will culminate in financial implosion if it proceeds unchecked. Only a modern central bank, with its unlimited power to create money, can with a high probability thwart such a process before it becomes destructive. Hence, central banks will of necessity be drawn into becoming lenders of last resort. But implicit in the existence of such a role is that there will be some form of allocation between the public and private sectors of the burden of risk of extreme outcomes. Thus, central banks are led to provide what essentially amounts to catastrophic financial insurance coverage. Such a public subsidy should be reserved for only the rarest of disasters. If the owners or managers of private financial institutions were to anticipate being propped up frequently by government support, it would only encourage reckless and irresponsible practices.... Another question is whether supervisory authorities have the expertise and resources to provide meaningful oversight and develop accurate assessments of the risk-taking activities of large, diversified, globally active financial institutions. If the answer is no, as might well be the case, should we nevertheless convey to market participants the sense that we are in fact adequately supervising such activities? Wouldn't that reduce the incentives for market participants themselves to provide discipline? Would a statement that all major financial firms, even the most diversified ones, are subject to coordinated supervision suggest a degree of support that effectively extends, to an unwarranted extent, the subsidy associated with national safety nets? Would it generate a degree of moral hazard that could itself be the source of systemic risk?
