Loosen Deposit Insurance Rules to Prevent a Bank Run

Visiting Scholar
Lawrence B. Lindsey
Let's get over the finger pointing. The media and political class are seeking someone, anyone, to blame for the current financial market meltdown: regulators allegedly asleep at the switch, lax monetary policy, greedy Wall Street executives. But there are far more well-intentioned culprits and far fewer pure victims than we would like to believe.

For two decades, politicians demanded ever easier access to mortgages for their constituents. In the name of shareholder value, financial firms were pushed to add leverage and reduce reserves. Even those usually thought of as victims--such as homeowners making $50,000 who thanks to creative mortgage finance and few demands for documentation moved into homes once occupied by people making six-figure salaries--should have known something was up.

History suggests it was always this way. Even Isaac Newton, of gravity fame but who also held the position of master of the mint, lost money in the South Sea Bubble. He got out, thinking it was a bubble, then got back in when it kept going up. He lost a small fortune in the process when it finally collapsed. Human greed, coupled with hubris, hasn't changed in the four centuries for which we have some sense of economic history.

So what's next? First, we need to build a firewall at a place far from the immediate flames, just in case the fire gets there. Second, we have to take a good measure of discretion out of the financial regulatory process. Rules were replaced with ever-so-sophisticated computer models, the parameters of which only included data from a market that was moving up. . . .

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Lawrence B. Lindsey is a visiting scholar at AEI.

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