Wednesday, June 1, 2011

Reckless Endangerment: Another Reason to End the Fed

The more I hear from Gretchen Morgenson and Josh Rosner, co-authors of a new book Reckless Endangerment, the more I like. The book is about the cause of the financial crisis to hit in 2008 setting in motion the Great Recession.

I have not read the book, so cannot vouch for its contents, but the following interview segments from The Daily Ticker are quite interesting and revealing. Morgenson and Rosner seem to have the inside scoop about how cozy the Federal Reserve is to large commercial banks, thereby subsidizing and encouraging ever-more risky malinvestment. They note how corporatist (in a fascist sense) the who financial system is. The scary thing is that they report that the flurry of bailouts, monetary activism, and regulation has left the system even more precarious than ever. So far the Fed has merely further enshrined the doctrine of "Too Big to Fail."

One area in which I disagree with them, however, is their view of regulation. They are right to recognize that bank activity needs to be regulated, however, they seem to imply that it needs to be more strongly done by the state. They accept Alan Greenspan's verdict from a couple of years ago that he and the Fed were wrong to rely on banks' self-regulation. The implication they take is that we need better real regulation by the government over the banking system.

The reason self-regulation did not work, however, is that they were protected from the best regulation of all: the regulation of the market. They did not have to regulate themselves, because they knew that the Fed had their financial back. The profit and loss system of the free market is a stern regulator, because the entrepreneur is encouraged simultaneously by both a carrot and a stick to make only wise, productive investments. With the Fed standing ready to fix problems due to too many unsound decisions, bankers and financial institutions made a tanker-load of entrepreneurial errors.

Morgenson rightly notes in the last segment that one of the Fed's main errors was that it equated safety and soundness with profitability. However, in our current Fed-supported fractional reserve system, a bank can generate temporary profits for quite some time by engaging in activity that actually contributes to, well, reckless endangerment. The regulation by the market that promotes safety and stability is a profit and loss system. It is only when banking entrepreneurs must bear the full cost of their losses that they are careful not to make foolish or even evil financial decisions. Accepting that any institution is "too big to fail" is to participate in dismantling the regulation by the market. "Too Big to Fail" is a natural outcome of a banking system backed by a central money creator we call a central bank.

In any event, I recommend the following interview segments:

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