This is from James’ post about Bush’s New Deal (link). He points to an article in the WSJ that has this part near the top.
Another proposal would be the creation of federal insurance for investors in money-market mutual funds, coverage akin to the insurance that currently safeguards bank deposits. The move is designed to stem an outflow of funds as consumers start to worry about even the safest of investments, a sign of how the crisis is spreading to Main Street. There is $3.4 trillion in money-market funds outstanding.
Great, so now we’ll have an even larger problem with moral hazard. People will now be inclined to take greater risks than they otherwise would since there is insurance to cover their losses or at least part of their losses. This is a bad idea. We already have rotten incentives by basing bonuses on Wall Street on annual performance vs. say performance over a 5 year period. We don’t need more risk taking, but less. This is like finding out you have a hole in the bottom of your boat and your solution is to make it even bigger. I guess one way to look at is that once your boat has sunk it can’t sink again, but frankly I find that solution of little comfort.
There was also this suggested policy as well.
At the center of the potential plan is a mechanism that would take bad assets off the balance sheets of financial companies, said people familiar with the matter, a device that echoes similar moves taken in past financial crises. The size of the entity could reach hundreds of billions of dollars, one person said.
For all their supposed brilliance (and I do think Bernanke is indeed very, very smart), these people have apparently learned nothing in their lives from any previous financial crisis. Nothing. As the article notes we did this before and yet here we are yet again with another financial crisis. By continualling bailing these entities out we reduce the downside to risky investments. We have here a great big fat time inconsistency problem. This is why discretionary policy is always failing in the long run. Reasonable and forward looking agents realize that the government will step in to cover loses if things get too bad. So people engage in activities that sooner or later result in things getting too bad and necessitating the intervention of the government.
These policies are likely to lay the seeds for our next crisis. Not directly, but by fostering irresponsible behavior and dependency on government bailouts.
