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When the long term loses its meaning, when institutions are told they can never fail, managers are given an incentive to put more capital at risk. If the investments go well in the short term, as subprime investments did for several years, the profit potential is huge. If they eventually fail, the downside is only so bad; the government will "do something" to keep the firms afloat.
And when these reckless investments do go well in the short term, they're sure to be repeated. If one financial giant is reaping huge profits from subprime, other firms are pressured to follow along--or else risk losing investors, customers, or employees who want to be part of the exciting profit machine. The long-term result of "too big to fail" is a gradual and overall decline in responsible risk-taking--with periodic crises like the subprime debacle.
Any doctrine that encourages overly-risky investing, and punishes sound risk-taking is unfair and destructive. We need to phase out "too big to fail" and replace it with a free market in banking, which would reward sound long-term lending and borrowing practices and punish irresponsible ones. Otherwise, the next financial market fiasco is just a matter of time.
this was originally published in march of 2008. what has our government learned since then?
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