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4 September, 2007

Therapy Failure - IUF Comment 01/2007

Sascha Tamm, IUF

The international financial markets do not work! Therefore, they have to be regulated, more transparency has to be ordered by the law, short-term liquidity has to be provided in order to rescue banks in danger of going bust - especially if they are public companies. One could have foreseen what is happening after the last weeks´ downward trend at the world's stock exchanges. But why is a downward trend a sign of market failure (whatever that may be)? Why not the upward trend ahead of it, which lasted some years, after all?  

 

 

The lack of transparency of different financial derivatives is said to be the cause of the turbulences. Investors, incapable of grasping the risk structure, just did not know what some banks had on their books. Furthermore, the rating agencies failed (and have to be regulated in some way as well, according to the German Minister of Finance, Peer Steinbrück). Maybe the rating agencies really have failed, maybe many banks and funds did invest too riskily. So, if there is widespread mistrust against banks, that is quite alright. It is a sign the market does work. It is an entirely normal process if American banks and funds perish that miscalculated everything.  

 

Much more dangerous than the demise of some banks and falling indices are the therapies used or planned against this "problem". First of all, there are the billions in liquidity injections in the form of fresh credit by the central banks. They help nurture the illusion that overall liquidity and interest rates are an easy exit to all economic woes. Unfortunately, this error has worked in practice for far too long and eventually contributed to the credit bubble in the US and elsewhere. The problem behind all this is the public monopoly on money.  

 

Rescuing banks and funds who consistently get it wrong is counter-productive and fuels speculations at the cost of third parties. Where there is always rescue, one can run virtually any risk. The risk of going bust is the best prevention against this.  

 

And one thing is clear: the necessarily, extremely short-sighted government, and its bureaucracies, are utterly incapable of adequately evaluating risk. When their calculations go wrong (from pensions to public investment projects), there is always the same saviour: the citizens. That is why the learning curve of government is even flatter than that of investors.  

 

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