barcode wrote:What caused this is stupid banks / lenders giving out money and buying stuff which were bad
Yes - isn't that terrible. Banks lending money and people buying stuff. What has the world come to!
This crisis is a complex thing, and it is being perpetuated by a hell of a lot of uncertainty. The UK has been harder hit than other countries, with the spectacular implosion of such institutions as Northern Rock, and the massive bailing out of other British banks.
Banks, like any business of course, can make mistakes and lose a lot of money. Our particular interest in banks is that when they collapse, they take OUR money with them. Hence we have tended to demand greater regulation of banks, imposing safeguards ostensibly to protect consumers interests. The most recent manifestation of this has been wide-reaching government guarantees of retail deposits. Now all this sounds fantastic to most people - except it fails to take into account some potentially nasty, unintended consequences.
An economist at the University of Chicago, Sam Peltzman, has offered some criticism of mandatory seatbelt laws that are present in many jurisdictions. This would seem to be quite controversial. Most people tend to regard the wearing of seatbelts in cars as a good thing - it's a safety feature. Seatbelts helps to minimise injuries and save lives. How could that be a bad thing? In fact, Peltzman hypothesised that mandating the use of seatbelts could encourage riskier behaviour. If you enjoy greater protection in your vehicle in the event of a crash, your incentive to avoid crashing is reduced. That doesn't mean there is no incentive to avoid crashing - you could still sustain injuries, and you would face the cost of repairs to your own vehicle, and so on - only that you might take fractionally less care while driving than if you knew you would be flung head first out the windscreen in an accident. (As an aside, some might suggest the best way to minimise the road toll and promote safe driving would be to require all vehicles to attach a giant, sharp spike to the steering column pointing straight at the driver's head. In virtually any crash, the driver would end up skewered. Increasing the cost of having an accident - in this case, the probability of losing one's life - would provide a strong incentive to drive as safe as possible.)
The 'Peltzman effect' has broader applicability than just seatbelts: it implies that any sort of safety regulation can actually promote riskier conduct. In a sense, efforts to protect banking customers represent a form of safety regulation. The more you try to protect customers, the riskier the investment strategies might become. Certainly in the case of a government guarantee of deposits, the customer has very little incentive to find the most sound institution in the market place - there's zero risk to them if the bank collapses. Hence they will be more likely to bank with higher-risk operators, who will generally be offering higher interest rates on savings. I'm thinking of the likes of IceSave.
Arguably, if there was absolutely no regulation or government intervention in the financial sector, consumers would demand greater financial security from their banks. If they could not be confident that their bank wouldn't collapse, they could simply choose to stuff their money under the bed. The banks need people to deposit money with them in order to exist, so they would change their business plans to adopt less risky strategies (such that they would minimise the risk of going bankrupt). Of course, there would be downsides to this approach as well - less lending, for instance, seems a probable outcome. However, an environment where financial security is demand-driven rather than attempted by policymakers, you might well end up with a more stable financial sector than what exists now. Paradoxically then, a system that on the surface seemed a lot riskier would probably end up being far safer.
