Contemplating the huge sums needed to bail out peripheral Europe, Gideon Rachman writes that he is feeling “strangely Austrian”. I confess to a similar sensation when contemplating banks. Eighteen months after the passage of the Dodd-Frank law, three-quarters of its Byzantine rules have yet to be implemented and there is little progress on the basic problem, which is that banks will take excessive risks with taxpayers’ money so long as they remain too big to fail. Meanwhile the Austrian antidote gets little attention. If you do not like government-underwritten, too-big-to-fail behemoths, you better embrace small-enough-to-fail hedge funds.
Most critiques of modern finance miss the mark. There is no point hoping, for example, that armies of Dodd-Frank enforcers will ever render finance truly stable. Finance is a system of promises about an uncertain future; barring the advent of some magical prediction machine, regulation cannot change that. Currencies will rise and fall; interest rates will fluctuate; some companies will succeed while others go bust. A good financial system will absorb these risks without taxpayers picking up the pieces. But the risks will still be there; financial firms will still blow up.
Nor is it easy to see how finance can be divided into stable, old-school activities and wild, casino stuff. Traditional bank lending is, in fact, conspicuously unstable, which is why governments are obliged to underwrite it with deposit insurance and lender-of-last-resort safety nets. Indeed, traditional bank lending frequently contrives to be both subsidised and uncompetitive. Companies can often raise capital more efficiently by issuing equities and bonds.