The Way Government Planners Think

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Today’s edition of “Spot the Non Sequitur” features former IMF chief economist Simon Johnson:

Essentially, financial firms have been buying the right to take on more risk. When things go well, executives in these firms get the upside – mostly in terms of immediate compensation, because few executives are compensated on the basis of risk-adjusted returns. That means that when the risks materialize and the firms suffer losses, the costs fall on taxpayers.

Ron Paul is right to point to imbalances of power and massive distortions within the financial sector. He is also correct that many government policies favor relatively few big firms — and favor them in a way that encourages excessive and dangerous risk-taking.

But Paul and others are wrong to argue that the government is the ultimate cause of all financial evil. Executives in financial firms want to take big risks. They like arrangements under which they win even when they lose.

Of course, what Johnson means is that deregulation + deposit insurance = moral hazard, so we need regulation to keep financial firms from taking excessive risks. The idea that moral hazard might be mitigated by eliminating deposit insurance, and letting the market discipline financial-market entrepreneurship, is unthinkable to regulators.

4:23 pm on January 23, 2012