Thursday, May 7, 2009

Systemic Risk: The Foxes Are Guarding the Henhouse

Systemic Risk: The Foxes Are Guarding The Henhouse

Seekingalpha; David Merkel; May 7, 2009

So the US government finally want to monitor systemic risk, after being whacked between the eyes? Perhaps they should ask who creates systemic risk? Who runs the system? Well, they do. The US Government, together with the Federal Reserve, have so much power that their decisions influence the system as a whole.

Dropping the Fed funds rate to 1% during 2003 helped drive systemic risk as they encouraged Americans to lever up and buy real estate. The Greenspan era was an exercise in providing liquidity beyond what was normally needed. Because of the demographics, more savers than spenders, the excess money inflated assets, not goods. People don’t complain when assets inflate and goods deflate. It is quite the reverse when goods inflate and assets deflate.

By running countercyclical policies, the Government/Fed trains the markets to realize that the Government/Fed has their back, and that they don’t have to worry about taking too much risk. There is the systemic risk. Risk can never be eliminated from the economy as a whole. To the extent that the Government moderates/absorbs/subsidizes the risks, the private sector gets more aggressive, raising the total risk level.

The US Government hasn’t done a great job managing the economy. Why should we entrust them with the tougher task of managing systemic risk? Oddly, managing systemic risk is easier if it was not managed. If there is no one there to protect you, what do you do to avoid malign swings in the economy? What’s that? Save more and grow slower? Yes. Don’t play it to the limit.

To guard against systemic risk, we would need a government over the US Government constraining its actions, preventing its procyclical policies, which are politically popular. There is no entity that can be that, particularly not the UN (useless nations). They have the same problems and worse.

Go ahead, let the US government try to eliminate systemic risk. They will quickly find that politics favors concentrated special interests that petition the government to increase systemic risk during boom times, leaving the economy to flounder during the bust times.

The Government can’t fight itself.

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