Interesting column in the FT by Martin Wolf about the bids to buy Northern Rock. Wolf thinks the bank should be nationalized and the shareholders wiped out for reasons of moral hazard and fairness. Of course many economists vehemently deny the importance or even the existence of moral hazard. The other extreme "no such thing as moral hazard" viewpoint is provided by Larry Summers in another recent FT column: http://www.ft.com/cms/s/0/5ffd2606-69e8-11dc-a571-0000779fd2ac.html
http://blogs.ft.com/wolfforum/2007/11/the-big-lessons.html#comments ---------------------------------snip I have tried to do so, though I recognise that I have not (yet) reached conclusions with which I am entirely satisfied. But I do know why this is so. It is, I admit, partly emotional: I find it hard to accept that the public sector should be forced to rescue the financial system from the consequences of its own greed and stupidity, again and again. It is also intellectual: defining the proper limits of such assistance is hard to do. Reasonable people are bound to differ on what these limits should be. The financial system makes much of its money out of financing investments in risky assets with short-term borrowings that it promises to redeem at par. Just putting this down should make any reasonable person shudder, since this is obviously an accident waiting to happen. And it does, repeatedly. But it is also a profitable accident waiting to happen, since the public sector is willing to help the financial sector redeem its borrowings (through the so-called "lender-of-last-resort" function) and, in extremis, to guarantee the value of a large part of its outstanding loans (i.e. deposits). Evidently, given its explicit and implicit guarantees to this rickety structure, the public sector has to regulate the capital and risk-taking of these institutions and, in the past at least, also the liquidity of the assets it holds. The financial sector, in turn, tries to get round these restrictions by placing some part of its business outside the regulatory net. The more complex the institutions, the easier the latter becomes. The reason I have spelled out these largely obvious points is that it only then that one can understand how difficult the position in which the authorities constantly find themselves turns out to be. They wish to prevent crises now, without increasing the likelihood of crises in future. It is not easy to make the judgements required to do this. But one point seems to me clear: the absence of insolvencies does not prove that the authorities are doing their job well. It could just as well prove the opposite. So the fact that Northern Rock ended up in huge difficulties does not prove the authorities got it wrong. It could just as well mean they got it exactly right.
