Americans are obsessed with the case launched by the Securities and Exchange Commission against Goldman Sachs. At last, many hope, wrong-doers will be punished. But this misses the point. The problem is more what is allowed than preventing what is not. This is not to deny that there was much fraudulent behaviour behind the financial crisis. As John Kenneth Galbraith wrote, the “bezzle – the stock of embezzlement” – always rises in good times. But the real catastrophe, as I argued last week, is the risk taken on by the gamblers working legally inside the machine.
The role of big institutions is obviously problematic: they are, at one and the same time, the house, the biggest players at the gambling tables, agents for the other players and, if all goes wrong, beneficiaries of limited liability and implicit and explicit government bail-outs. This is a guarantee of repeated catastrophe. Under the gold standard, the scale of bail-outs was constrained. In a fiat system, there is no such limit, until the value of money collapses.
So what is to be done? Let us start with the least one could do to make greater stability credible.