Streetwise Professor

March 1, 2010

Repeat Page for Dr. Strangelove

Filed under: Economics,Financial crisis,Politics — The Professor @ 2:47 pm

My dad told me that he’d seen a CNBC interview with some Congressmen advocating a law to prohibit the government from bailing out financial firms.  It is hard to get excited about this watching what’s going on in Europe.  The Maastricht Treaty expressly proscribes bailouts of member countries, but there are all sorts of plans under consideration to do just that for Greece, while avoiding a direct government-to-government bailout.  These schemes would utilize various cutouts, such as having German banks buy Greek government debt, and the German government providing guarantees to the banks.

As I’ve written before, the difficulty with too big to fail is the inability of governments to commit credibly not to bail out.  The Europeans recognized this problem, and attempted to write language in the EU founding treaty that would commit the members not to bail out others who are failing.  But where there’s a will–or, more accurately, a lack of will to adhere to commitments–there is a way.  This is why TBTF is so intractable, and why we should be wary of any claims that this legislative measure or that here in the US will make the problem go away.

I say only somewhat facetiously that what is needed to prevent TBTF is a financial doomsday machine, a la Herman Kahn/Dr. Strangelove, that would automatically impose a prohibitive cost on any government that attempts to bailout.  Short of that, with mere humans in charge, credible commitments are nearly impossible.

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