28 March 2008

Subsidies and Regulation

The hot topic among economists right now (Tyler Cowen, Russ Roberts, Arnold Kling, Megan McArdle) is whether the Bear Stearns bailout was a good idea or not. Some people both believe it was a good idea and that we need more regulation of the financial markets.

Of course if we continue to bail out failing businesses, more regulation is necessary. Tyler Cowen says so, too.
As long as the Fed and Treasury are providing a safety net, insisting on capital requirements is entirely reasonable and it lowers moral hazard. If you're going to bail out your friend in a poker game, you can ask him not to bet too much beyond his chips.
I not only have great respect for Cowen's analytical ability, but it agrees with something I've been saying for years: Any time you want benefits from government, it is justified in regulating your actions, and it will regulate your actions. Or, in short, the more you ask for from government, the more freedom you have to surrender.


Scott Hanley said...

The IMF thinks nothing of dictating economic policies to loan recipients. Morally, it seems unreasonable to complain about some regulation at the same time you're being saved from the consequences of your own folly. Now if only the regulation can be done wisely ....

James K said...

scott: Wise regulation is good, but only if you can get a pony as well :)

I agree with the basic point made by Cowen. I think you do need to bail out companies like Bear Sterns, not for their sake, but to stop contagion. But it has to hurt the shareholders and the government is within its rights to put some regulations in place to protect against moral hazard.

Of course the question is what regulation to put in place. Some is not the same as more. No ssytem is foolproof and it may be that you ahve the right amount of regulation at the moment.

James Hanley said...

I agree that if you accept the help from government, you can't complain about the regulation. That's not directly my point--which is that you can't expect help without regulation--but it's a strong supporting point.

However I tend to oppose both the subsidies/bailouts and regulation as re-creating the problems that lead to the need for bailouts and further regulation. It's the moral hazard problem. We give them more incentive to take bad risks because they believe we'll bail them out. When they fail, we see it as a situation that requires a bailout, and as a situation that requires more regulation, but then we just set the grounds for future failures.

As to the contagion theory for the Bear-Sterns case, I'm speaking about general rules. I'm simply not qualified to talk about this specific case, since I don't study financial markets.

James K said...

I agree with you point as well. I also oppose bailouts in general - privatise the gains, privatise the losses.

I think in the case of banks you do need some kind of bailout, but only to protect the depositors. Ideally the shareholders should lose it all.