Which is the more glamorous occupation: fire fighter or fire prevention officer? Which is the more important? Let's think of the financial analogy. Which is the more glamorous: dealing with financial crises or designing policies to prevent future crises? Once the crisis is over and fixed, politicians and the public have little interest in designing policies to prevent future collapses as such things do not capture the public imagination. In addition, bankers have every incentive to resist policies designed to prevent future crises because they are costly to implement. Click here to read Robert Shiller's take on this.
The existence of a fire service which quickly and efficiently reacts to fires means that, unless compelled by the government, people and firms under-invest in fire prevention. Indeed, there is even the possibility that the existence of such a fire service increases the probability and severity of fires. The same holds true in finance. The existence of bailouts and government rescue schemes means that banks will under-invest in risk management and end up taking greater risks. Is it time to get rid of the financial rescue service or is it time to get tough with banks?
The existence of a fire service which quickly and efficiently reacts to fires means that, unless compelled by the government, people and firms under-invest in fire prevention. Indeed, there is even the possibility that the existence of such a fire service increases the probability and severity of fires. The same holds true in finance. The existence of bailouts and government rescue schemes means that banks will under-invest in risk management and end up taking greater risks. Is it time to get rid of the financial rescue service or is it time to get tough with banks?