By JOHN H. COCHRANE,
If you are a company, why issue stock when you can just borrow, knowing that the government will prop up your debt or bail you out, as it did for the airlines ? If you are an investor, why hesitate to buy shaky debt, knowing that its value will be guaranteed by another “whatever-it-takes” commitment from the Fed in bad times?
No wonder America is awash in debt. Everyone assumes that taxpayers will take on losses in the next downturn. Student loans, government pensions, and mortgages have piled up, all waiting their turn for Uncle Sam’s bailout. But each crisis requires larger and larger transfusions.
Bond investors eventually will refuse to hand over more wealth for bailouts, and people will not want to hold trillions in newly printed cash. When the bailout that everyone expects fails to materialize, we will wake up in a town on fire – and the firehouse has burned down.
In 2008, regulators and legislators at least had the sense to recognize moral hazard, and to worry that investors gain in good times while taxpayers cover losses in bad times. But the 2020 blowout has been greeted only with self-congratulation.
The same Fed that missed the subprime-mortgage risks in 2008, the pandemic in 2020, and that now wishes to stress-test “ climate risks ,” will surely miss the next war, pandemic, sovereign default, or other major disruptive event. Fed regulators aren’t even asking the latter questions.
And while they issue word salads about “ interconnections ,” “ strategic interactions ,” “ network effects ,” and “ credit cycles ,” they still have not defined what “systemic” risk even is, other than a catchall term to grant regulators all-encompassing power.
Regulators will never be able to foresee risks, artfully calibrate financial institutions’ assets, or ensure that immense debts can always be paid. We need to reverse the basic premise of a financial system in which the government always guarantees mountains of debt in bad times, and we need to do it before the firehouse is put to the test.
Better regulation can bridge partisan divides. The left is correct that big banks are inefficient oligopolies that serve most Americans poorly. But it has the cause wrong. An immense regulatory compliance burden is a major barrier to market entry.
Calls for “more” regulation are meaningless. Regulations are either smart or dumb, effective or ineffective, full of undesired consequences or well designed. We need better regulation. We need more capital, not many more thousands of pages of rules. Capital provides a buffer against all shocks, and it does not require regulators to be clairvoyant. The Fed has scandalously blocked narrow-banking enterprises and payments providers that could help serve many Americans’ financial needs.
Before turning to healing the planet and righting injustice, the Fed should be held to account for how badly it is doing on the basic task of protecting the financial system.
John H. Cochrane is a senior fellow at the Hoover Institution.
This commentary was published with permission of Project Syndicate – Why Isn’t the Fed Doing its Job?
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