Thursday, October 09, 2008

Financial Fuss (7) - Fostered Foolishness

Many people are blaming greed, but this is not really the issue. The world will always have greedy people and many of them will find their way into banking.

The financial system has come under pressure, because over the last decade greed has not been tempered by fear of failure. The actions of the government and the Federal Reserve over the last three decades have minimised the risk of failure for most of the financial sector.

This goes back a long way. It probably started with the 1987 share market crash when the Fed minimised the damage by pumping their money machine. The message was reinforced during the Savings and Loans crises of the 1990s. These institutions had moved into new areas of business and made unwise and foolish loans. When things went wrong, the government came to their rescue.

The rescue of Long Term Capital Management is another example. This company had used clever mathematical modelling to enter what proved to be foolish trades. The Fed rescued LTCM, so the clever people learned nothing their failures, except the need to be more clever.

When the dot-com bubble collapsed in 2000, the Fed boosted the money supply to prevent the markets from falling to far. Although this led to the housing boom, the government is riding to the rescue again.

Some parents rescue their children again and again, even if they keep on making the same mistakes. However, rescue without repentance reinforces rebellion.

The current rescue of the American financial system is creating the conditions for the next crisis, which will lead to calls for an even bigger rescue.

This full series is here.

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