Tracing consequences both seen and unseen.
Lee SharpeFinancial Reform
Posted at 11:19 pm on May 23, 2010, by Lee Sharpe

With the financial reform bill through both houses of Congress, it’s time to look at its contents, which do not look good at all for fans of limited government.

Banks are taxed to pay for bailouts. Since banks will pass these taxes on to consumers, really it means bank customers (almost all Americans) will be paying for more bank bailouts. What those who take this view fail to see is that making banks “too big to fail” means that those banks will engage in as risky behavior as possible. Did their risks pay off? They keep the profits. Did the risks not pay off? That’s not on the banks, because the American public will be covering those losses instead.

Ah, say the the more nuanced supporters of this legislation. That is this bill, to quote CNN:

New oversight power: Creates a new oversight council that would look out for major problems at large financial firms. The Treasury Department gains a key role in enforcing tougher regulations on larger firms and watching for systemic risk. The council also has veto power over new rules proposed by [a] new consumer regulator.

How much risk is too much? I don’t know, neither does the governement, and probably the firms don’t know either. But if firms are all free to be as risky as they like — receiving the profits when they’re correct and being forced to endure the losses when they don’t (even at the risk of going bankrupt) — then the market will learn which risky behavior to avoid and which works.

Instead government is guessing how much regulation is appropriate. Since the government (through creating expectations and in some cases guarantees of bailouts) is already encouraging banks to provide risky loans, if regulations don’t mitigate this enough, the banks have to be bailed out at the public’s expense. If the regulations mitigate this too much, reasonable loans that banks and recipients would both agree to the terms to will be banned by the government, slowing economic growth.

Banks profiting from their investments is good for everyone. Home buyers and small business owners often need loans to succeed. Banks make more money in the long run, which they can use to make even more loans to others. Without the government’s help, this has been occuring to the mutual benefit of investors and loan recipiants. These home purchases and small businesses create direct and indirect employment. Having bankers and investors make their own choices and receive both the positive and negative consequences of their lending decisions is a much more effective way of doing that. It also doesn’t cost the public a thing.

Filed under: Finance, Regulation
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Henry Hazlitt"[T]he whole of economics can be reduced to a single lesson, and that lesson can be reduced to a single sentence. The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups."
Henry Hazlitt, Economics in One Lesson






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