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International Officials Attempt to Deal with "Systemic Risk"

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It seems regulators wish to take another direction when it comes to the creation or prevention of bubbles in our economy. According to a Washington Post article, international officials have been examining a way to deal with a concept known as "systemic risk." Systemic risk is the risk of a spurt of economic growth that is caused by a bubble in our economy, as was the case with the recent housing market crash.

Systemic risk seems to be a relatively misunderstood phenomenon, some central bankers and regulators wish to control this risk by focusing on the rapid increases in prices associated with a bubble. The main issue of concern amongst them is when to step in and take action to prevent a sector of the economy from growing too fast and for the wrong reasons.

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According to The Post's article, Greenspan's indefinite reductions in interest rates to control the fallback of the dot-com bubble were actually in place because ""regulators assumed that markets with large numbers of people with enough information and the ability to move money freely could assess the risks of different investments and look out for themselves."

This is very interesting because not only did the perpetually low rates contribute significantly to the growth of the housing bubble, but Greenspan himself advised American citizens in 2004 that adjustable-rate mortgages were good for borrowers, when in reality such mortgage instruments only help commercial banks and lenders. More than $1 trillion of ARMs were reset in 2007. Payments for some mortgage holders increased by as much as 70 percent. The usage of ARMs was a major catalyst in the growth, and bursting, of the housing bubble.

So, now, because of poor government oversight, officials wish to implement policies that have the government overseeing economic growth, a policy that grants them the ability to make economic decisions for one or several sectors alone. Fortunately, it seems that Bernanke has some sense concerning the idea of controlling specific sectors of the economy with "very blunt tools" of the central bank. He stresses that officials should warily approach the implementation of such practices.

One solution the group discussed was forcing potential home buyers to make larger down payments when purchasing homes. Ignoring that the majority of the home buyers whose mortgages defaulted were given credit without a good credit score and that banks charged high interest on low-payment, adjustable mortgages, largely due to government policy in regards to low-income borrowers, forcing borrowers to put a larger down payment is generally a good way to assess and reduce risk, but such decisions should be left to those giving the loans, as they are in the best situation to assess the borrower's risk.

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Taking steps to prevent bubbles creates a paradox. Generally, it is the policies of the central bankers and government officials that cause bubbles in the first place as they try to manipulate the course of the economy. Such was the case with the housing bubble. Now, the same regulators wish to achieve the opposite effect through the exact same policies, in reverse. It seems it would be better to let lenders assess risk on their own, of course realizing that when they do so poorly, they will suffer financially. Insurances by the government on low-credit loans and consistently low interest rates lead banks to take on poor credit borrowers because the risk associated with doing so is reduced significantly. If these incentives are taken away, lending will be done with the appropriate amounts to the appropriate people, out of the interest of their own income. If lenders do not assess the risk correctly, they suffer financially and the rest of the industry learns.

I want to make clear that I do not think there should be a lack of financial regulation in general, but policies such as these do not help the majority of Americans in the long run, nor the economy. Government regulations should be designed to help the majority of Americans, not a small wealthy percentage. Considering what happened the last time our central bank tried to control the exact course of our economy, it is only natural to feel reluctance when they speak of doing it again.
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www.economyincrisis.org
Writes for EconomyinCrisis.org. Attends school at The Ohio State University, part-time, earning a BS in Business Finance.

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