Why Tobin Taxes Wouldn’t Have Prevented The Financial Crisis

The Economist discusses the populist rhetoric from Gordon Brown on the topic of the Tobin Tax, a fee levied by government on any financial transaction. US Treasury Secretary Tim Geithner admits that any such policy would be useless unless adopted world-wide, because trading would simply migrate to unregulated jurisdictions.

Public support for such measures is worrying though, as the Tobin Tax is ineffective in preventing risk-taking in financial markets or harmful asset price bubbles. It would be extremely effective at making markets inefficient though..

Rolling Back the Rules of the Road

The Christian Science Monitor has a fascinating piece on how traffic laws cause accidents, by diminishing the attention that drivers pay to the roads and reducing their reliance on their own best judgement. Could their complete absence improve matters?

There is clearly a simple trade-off here. Drivers can choose to concentrate on the road, thus making them better equipped to react to unexpected occurrences and more aware of their surroundings. They could alternatively just trust the lights and the signs.

Passing the Buck

The New York Times reports as the largest pension fund in the country, the California Public Employees Retirement System (CalPERS) sues credit rating agencies for forcing them to make risky investment decisions and ignore the potential for a market down-turn. Oh, no wait. That’s not an accurate description of the events that transpired at all.

Common Threads of Depression

In 1890, the Silver Purchase Act threatened to cause inflation – to the benefit of farmers and miners, at the expense of business interests and banks. As the Great Depression of the 1930s raged, real wages of labourers continued to climb.

The most recent financial crisis was characterised by defaulting sub-prime borrowers, who were lent more money than they could afford. It is no coincidence that in each case, depression was invited or prolonged by politics championing a reallocation of society’s resources.

The World Without Limited Liability

It was suggested recently here that limited liability had proven inappropriate for the banking system. Gambles which are rational from the perspective of individual banks can threaten the economic system, when business confidence is affected by the aggregated effect of all these risks.

Banks are all interdependent. There were other problems that contributed, but no doubt the contribution of stockholders and traders who were indifferent between leaving a company destitute, or insolvent and indebted for millions. Is it possible though to imagine a world without limited liability?

How to Reform Risk Management

In recent times, traders have been accused of taking excessive risks. Unfortunately, the structure of remuneration in financial markets tends to exacerbate animal spirits by creating incentives for risk-taking.

Traders benefit dramatically in prestige and bonuses when successful. Meanwhile, they don’t suffer when they do badly as society foots the bill. This agency problem in finance is described as the ‘Trader Option’.

Making Bondholders Pay?

The Irish Economy debates the merits of proposals from Fine Gael to allow the banks to default on bondholders. There have been naïve claims from the government that such a move would increase the cost of lending for the state.

Meanwhile, such talk pushes up the cost of lending for Irish banks. It effectively makes the guarantee of bank debt by the government null and void in the minds of investors, and chills them to the prospect of lending.

The Price of the Euro

David McWilliams offers his solution to Ireland’s problems by suggesting the abandonment of the Euro. It is true that Ireland can only become competitive again by repricing itself, whether through deflation or devaluation. However, the Maastricht Treaty outlines no route for countries to leave the monetary union.

The transition mechanism is the most difficult aspect of the debate, but a topic which has remained relatively untouched so far by any commentators. First of all though, note that devaluation is no panacea.

Regulating Government Intervention Away

Government intervention in the banking sector was motivated by an unwillingness to let banks fail due to ‘systemic importance’. Meanwhile, there was no efficient market for risk because banks expected to be bailed out in their hour of need, even though diversity in this area is extraordinarily beneficial. The solution is smart regulation to eliminate the need for massive government intervention.

NAMA’s Free Lunch for Shareholders

Since first advocating the Nationalisation of Ireland’s banking system in February here, public dialogue has shifted the focus of the debate. Although not lightly considered, Nationalisation is still a better option than the plan currently proposed by the government under the National Asset Management Agency. At least the government would then be pouring money into assets that it already owns, rather than simply bailing out share-holders.