Arnold Kling  

Those Wild and Crazy Markets

Voting... Will Networks Blow It Again?...

Uwe Reinhardt writes,

Iceland's problem, like that of the rest of the world, is rooted in the unquestioned belief in the free market doctrine that swept the world during the past two decades...Iceland's liberal government thought it was safe to let the island's bankers loose in a global market of debt and asset financing.

...under European regulations, Iceland is obliged to pay 20,000 euros to each individual foreign depositor in Icelandic banks.

It's interesting how often it turns out that where there is a failure of the wild and crazy markets, somewhere in the background is a government guarantee. Maybe governments that try to guarantee too much wind up guaranteeing nothing. Maybe the U.S., too, will learn this lesson the hard way.

Thanks to Phil Izzo for the pointer.

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COMMENTS (3 to date)
BL writes:

Does Reinhardt believe half of the things he writes? If so, I really sympathize for his students, plus the title of "James Madison Professor" is perhaps the least appropriate ever given.

tadhgin writes:

The next sentence says: "In toto, however, that guarantee alone amounts to 60 percent of Iceland's GDP"

Reading some more about what happenened in Iceland will tell you that the problem is a lot bigger than 60% of GDP.

The rest of the debt is owed on "wild and crazy markets"

B.H. writes:

If Iceland has a comparative advantage in offering banking services to the world, what is wrong with that? How is it different from Kansas specializing in wheat or Kuwait in oil?

The crisis is the result of not enough financial innovation and activity. The risk of bank failure needed to be spread globally rather than concentrated in Iceland.

Lesson: always diversify. We need lots of wild and crazy markets, including CDS, to do that.

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