Manias, Panics and Crashes: A History of Financial Crises, Sixth Edition by Kindleberger Charles P. & Robert Z. Aliber

Author:Kindleberger, Charles P. & Robert Z., Aliber [Kindleberger, Charles P.]
Language: eng
Format: epub
Publisher: Palgrave Macmillan - A
Published: 2011-08-09T07:00:00+00:00

10

Policy Responses: Benign Neglect, Exhortation, and Bank Holidays

If many financial crises have a stylized form, should there be a standard policy response? Assume plethora, speculation, panic; what then? Should the government authorities intervene to cope with a crisis and if so when? Should they seek to forestall increases in real estate prices and stock prices as the bubble expands so the subsequent crash will be less severe? Should they prick the bubble once it is evident that asset prices are so high that it is extremely unlikely that increases in rents and in corporate earnings could be sufficiently rapid and large to ‘ratify’ these lofty prices? When asset prices begin to fall, should the authorities adopt measures to dampen the decline and ameliorate the consequences?

Virtually every country has established a central bank to prevent or minimize shortages of liquidity, especially during a financial crisis. Many countries have a deposit insurance arrangement to reduce the likelihood of runs on their banks and to forestall what otherwise could be a self-fulfilling prophecy that a shortage of liquidity would trigger a solvency crisis. Even when there is no formal insurance for bank deposits, individuals in many countries believe that their governments will ensure that they will not incur losses if the banks should fail – in effect, the banks will be nationalized and the government will become their owners.

Chairman Greenspan of the Federal Reserve initially took the view that the Fed should focus monetary policy on the achievement of a stable price level – or at least a low inflation rate – and the macro-employment objectives. Then as the US financial system imploded in the last few months of 2008, he seemed more open to the idea that the Fed should have paid more attention to increases in real estate prices.

This chapter centers on the management of financial crises – it first deals with regulatory measures that might be adopted to reduce the susceptibility of financial arrangements to manias and then with the approach to panics. The next chapter focuses on the domestic lender of last resort and the following one on the lender of last resort in an international context. This chapter considers the Austrian view that the best remedy for panic is to ‘leave it alone’ – to let it run its course, and to allow the economy to adjust to the decline in household wealth, the de-capitalization of the banks, and the slowdown in household and business spending that would follow from the declines in the prices of real estate, stocks, and commodities.

The moral hazard argument is the primary rationale for non-interference by the government; the view is that the more interventionist the authorities are in the current crisis, the more intense the next mania will be. The argument is that intervention skews the risk and reward trade-off in the minds of many investors – both the shareholders in banks and perhaps some of the creditors of the banks including those who own the bonds or other fixed price claims on the banks – by reducing both the likelihood and scope of future losses.

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