Oct 7, 2008

Should we let the financial markets shrink?

I was pondering today in the computer room whether governments should or should not rescue the financial system with our money. I have not found yet a convincing reason why we should not. Ken Rogoff explains why we should be skeptical about a full bail-out plan. Mr. Rogoff, Isn’t any plan better than none?

"I, for one, am not convinced. Efficient financial systems are supposed to promote growth in the real economy, not impose a huge tax burden. And the US financial sector, in greasing the wheels of the real economy, has been soaking up an astounding 30% of corporate profits and 10% of wages. Thus, unlike in the 1930’s, the US faces a hypertrophied financial system. Isn’t it possible, then, that rather than causing a Great Depression, significant shrinkage of the financial sector, particularly if facilitated by an improved regulatory structure, might actually enhance efficiency and growth?"

I never thought about the issue this way, but I tend to buy this argument. Sophisticated financial instruments spread the risk, and this creates more credit opportunities. True. But are we sure that everybody working in the profession was fully aware of what they were buying?And can we say that consumers are fully ready to understand all the investment plans that financial planners are willing to propose? As long as the industry is dominated by lack of information on both sides, need to make sure also that the bad banks disappear, otherwise only savers will end up bearing the costs.

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