Get Warren’s RSS FeedWe have just experienced the consequences of excessive risk taking by financial enterprises, real estate speculators, and overstretched homeowners fueled by the expectation that taxpayers would cover their losses if risky bets failed. Washington’s response to the financial crisis has confirmed these expectations and is thus compounding the problem for the future. Recovery of the U.S. economy and of the financial sector that finances it requires stabilizing the rules of the game and restoring market discipline of risk taking. Washington must give up the conceit that it can reliably micromanage socially desirable outcomes successfully. Regulatory rules must return the cost and reward of risk taking from the taxpayer to the risk taker. The moral hazard of financial risk takers taking the profits and tax payers bailing them out when their bets fail has seriously corrupted our financial system. It will not be easy to put that genie back in the bottle, but it can be done. (more)
Warren Coats - Dr. Coats has over 26 years of experience in monetary policy and central banking in developing and transition economies. When he retired from the IMF May 2003 he was Assistant Director of the Monetary and Financial Systems Department (MFD). Prior to that he was a visiting economist at the Board of Governors of the Federal Reserve System and at the World Bank and an assistant professor of economics at UVA.
As the amount of a debt grows larger, the payment of interest it promises to lenders increases. If it grows faster than the borrower’s income, the burden grows as a share of his or her income. If the burden grows too large, the promise must be broken, leaving those who lent the money holding the bag. As the prospect of default increases, bondholders demand higher interest rates to compensate for the risk. No one knows exactly where the default cliff is and thus when to dump bonds, but everyone knows when you have driven off it. (more)
If AIG, the insurance giant bailed out by the U.S. government, had failed a large number of assets such as mortgage-backed securities would have lost their insurance against losses (called credit default swaps) causing their value in the market to fall. (more)
