Bank Crisis Dissected

On a number of occasions on this blog, I have expressed the view that tighter regulation of hedge funds is not necessarily in the public interest. This view is consistent with the thinking that limited regulation does have immense benefits compared to costs. Given the spate of collapses and rescues that is ongoing in the US starting with the sub-prime mortgage crisis and is now squarely hurting Wall Street banks,it is important to consider what structural factors have created the crisis.

Without doubt, a number of these banks were very highly leveraged and for a time made huge profits from sophisticated financial instruments such as derivatives. Joseph Stiglitz, Kenneth Rogoff and Thomas Friedman all have had their take on the issue. However, I think that Robert Samuelson's piece here not only tightly states what the problem is, but explains the miscalculation that resulted from the same models.

I am unsure that Wall Street will not be the same again as similar claims were made during the collapse of LTCM a decade ago, but it is clear that readjustments will take place in financial services houses in addition to there being stronger claims for regulation of these firms who appropriate profits for owners but require public money to ensure their survival during crises. I am all for prudent regulation unless it is made clear that no public money is to be used to save any private firms. With the rescue that has occurred already, there's a real moral hazard and it will only be a while before the geniues are back with presumably better models.