More on the financial crisis

I am not a regular on the Freakonomics* blog, but I surf by every now and then. Nowadays the financial crisis in the US and Europe is of course in focus. This piece by Erik Hurst has an interesting discussion of why a vibrant banking sector is necessary and a review of the history of bank regulations in the US. He pinpoints that earlier deregulations reduced interest rates and gave more people access to credit. The demands for more regulation that has surfaced during the current crisis concerns Hurst as he is afraid that the (social) costs these regulations may impose would not get the appropriate attention.

On my part, I wonder what kind of regulations people have in mind. Laws against subprime lending? I think that would lead to overly complicated regulations impossible to enforce. But somehow putting a ceiling on the risks a bank is permitted to take do make sense. As the government insure deposits there is risk of moral hazard.

There is more interesting stuff on the Freakonomics blog. Here is a discussion of an alternative plan for the proposed bailout. The idea, conceived by Lucian Bebchuck, is as brilliant as it is simple and straightforward. One of the problems with the bailout plan that was voted down by congress last night is that the price paid for assets is ‘unfair.’ A solution is to divide the money to be injected between different managers and let them compete:

Suppose that the economy has illiquid mortgage assets with a face value of $1,000 billion, and that the Treasury believes that the introduction of buyers armed with $100 billion could bring the necessary liquidity to this market.

The Treasury could divide the $100 billion into, say, 20 funds of $5 billion and place each fund under a manager verified to have no conflicting interests. Each manager could be promised a fee equal to, say, 5 percent of the profit its fund generates — that is, the excess of the fund’s final value down the road over the $5 billion of initial investment. The competition among these 20 funds would prevent the price paid for the mortgage assets from falling below fair value, and the fund managers’ profit incentives would prevent the price from exceeding fair value.

* Freakonomics is a blog based on the same ideas as the book by the same name (that is, a blog developed from a book, oposit to the recent trend of books based on popular blogs). The book is a demonstration of both the power of microeconomic theory (combined with statistics) and the talent of Steven D. Levitt. I recommend the book to anyone sligthly interested (in economics, or, more extraordinary, Levitt himself for that matter) or just generally curious.

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One Response to “More on the financial crisis”

  1. My last post on the crisis (yeah right) « Kvams Says:

    […] Earlier I wrote about the problem the managers of the bailout funds will face valuating the rotten assets, and a possible solution.  As Stiglitz points out, paying a fair price for the bad loans will not fill the hole in the banks’ balance sheets. The solution of a decentralized bailout, thus, is clever, but it would work oposite to the overall goal with the bailout. […]

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