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  • The Unregulated Bailing Out the Regulated

    Great observation by Michael Barone on Treasury Secretary Timothy Geithner’s latest bank bailout plan:

    Democrats like Barack Obama and Barney Frank, at least on the campaign trail or in sound bites, have portrayed the financial crisis as the product of deregulation. The solution, they say, is more regulation.

    My American Enterprise colleague Peter Wallison has argued powerfully that this is a bad idea. Neither the Federal Reserve or other regulators identified the systemic risk which caused this crisis. Neither did most financial institutions or investors. Systemic risk is hard to identify for the very reason that it is systemic: It results from just about everyone doing what turns out to be the wrong thing.

    Which takes me back to the Geithner paradox. He has singled out unregulated institutions as the only ones to bail out regulated institutions. Yes, financial markets do need to be regulated, in intelligent ways. We need rules of the road and the ability to prosecute fraud. With hindsight, we can identify bad decisions by regulators which helped produce this financial crisis (the government’s implicit guarantees of Fannie Mae and Freddie Mac, the unduly high leverage allowed to banks and investment banks). But regulation does not automatically produce safety. It may very well, as Wallison argues, increase rather than mitigate systemic risk.

    Geithner, as I see it, is asking the unregulated players—the hedge funds and private equity firms—to do what Wallison recommended that the government do, buy the troubled assets “at their ‘net realizable value,’ which is based on an assessment of their current cash flows, discounted by their expected credit losses over time.” He’s trusting the unregulated players, rather than the government, to discover what that value is, by subsidizing their investments while limiting their downside risk.

    This may work as intended. I certainly hope so. But it does give us some things to keep in mind as we ponder how financial markets should be regulated in the future. We don’t want to regulate every player strictly. There is a place for unregulated operators. And tight regulation will never automatically protect us against systemic risk.

    Posted in Economics [slideshow_deploy]

    4 Responses to The Unregulated Bailing Out the Regulated

    1. ra,ohio says:

      Why the HELL is the government demanding regulation of the private sector when IT is obviously unregulated and can only be every two years.

      The audacity of these people is unbelievable.

      Obammmmmmmmmmaaaaaaaaaaaaa want's this and Obaaaaaaammmmmmmaaa

      want's that.

      This administration, and congress makes me want to heave.

    2. mike baker Dallas Ce says:

      It's time for the Supreme Court to enforce the Ninth and Tenth Regulations on the biggest business of all.

    3. cj, medford, Or says:

      Here we go again! If you don't think Geithner's proposal make sense, come up with your own proposal. Let's move on from the pat answer of "no more regulation" or "let the free market determine the fate" or " the real problem was Congress with Freddie and Fannie" etc. Yes many things have caused the situation the world is in now including non-regulated financial institutions such as AIG and others who in all actuality commited fraud by placing bets with basically no collateral to make up the downside. This same point holds for the Budget…stop the whinning and put forth some real solutions to solve our problems and not just rhetoric to appease a certain philosophy.

    4. Marshall Hill MI. says:

      I am dismayed that anyone in Our Country can con-sider Barney Frank as anything other than a very

      distastful THUG, who has no respect for anyone or

      even himself! This guy is a disgrace to this great

      land that lets him stay here! If this is the future Public Servant then get rid of them all and

      start over!

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