From the Economist:
Five devastating slumps—starting with America’s first crash, in 1792, and ending with the world’s biggest, in 1929—highlight two big trends in financial evolution. The first is that institutions that enhance people’s economic lives, such as central banks, deposit insurance and stock exchanges, are not the products of careful design in calm times, but are cobbled together at the bottom of financial cliffs. Often what starts out as a post-crisis sticking plaster becomes a permanent feature of the system. If history is any guide, decisions taken now will reverberate for decades.
This makes the second trend more troubling. The response to a crisis follows a familiar pattern. It starts with blame. New parts of the financial system are vilified: a new type of bank, investor or asset is identified as the culprit and is then banned or regulated out of existence. It ends by entrenching public backing for private markets: other parts of finance deemed essential are given more state support. It is an approach that seems sensible and reassuring. But it is corrosive. Walter Bagehot, editor of this newspaper between 1860 and 1877, argued that financial panics occur when the “blind capital” of the public floods into unwise speculative investments. Yet well-intentioned reforms have made this problem worse.
…..To solve this problem means putting risk back into the private sector. That will require tough choices. Removing the subsidies banks enjoy will make their debt more expensive, meaning equity holders will lose out on dividends and the cost of credit could rise. Cutting excessive deposit insurance means credulous investors who put their nest-eggs into dodgy banks could see big losses…..
Read more at Financial crises | The Economist.
