Creditors Need to Take Some Risk

Tyler Cowen has a good op-ed in the NYT pointing out a key factor in the bailouts—the true recipients are the creditors and that might cause future problems:

What the banking system needs is creditors who monitor risk and cut their exposure when that risk is too high. Unlike regulators, creditors and counterparties know the details of a deal and have their own money on the line.
But in both the bailouts and in the new proposals, the government is effectively neutralizing creditors as a force for financial safety. This suggests a scary possibility — that the next regulatory regime could end up even worse than the last.
The more closely a financial institution is regulated, the more it will be assumed that its creditors enjoy federal protection. We may be creating a class of institutions whose borrowing is, in effect, guaranteed by the government.

Posted by Eddy Elfenbein on April 4th, 2009 at 11:28 pm

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