Wrong Incentives from Financial System Fixes

REACTING TO THE SPENDING SPREE: POLICY CHANGES WE CAN AFFORD, Terry L. Anderson and Richard Sousa, eds., Hoover Institution Press

Stanford Law and Economics Olin Working Paper No. 383

22 Pages Posted: 31 Oct 2009 Last revised: 19 Nov 2009

See all articles by Stephen Haber

Stephen Haber

Stanford University - Hoover Institution and Political Science

F. Scott Kieff

George Washington University - Law School; Stanford University - Hoover Institution on War, Revolution and Peace; McKool Smith

Date Written: October 31, 2009

Abstract

Few doubt the seriousness of the recent crisis afflicting the financial systems of the United States and the world. Few claim that nothing needs to be fixed. And few have missed the major debates about what types of solutions are best - often conducted at high volume, intensity, and frequency. So rather than try to add to one side or the other of the well-rehearsed arguments about each type of proposed reform, we try to refocus the analysis on some core incentives: when the basic rules of the game are changing, property rights and the rule of law are too ill-defined, creating exactly the wrong incentives for investment and economic growth. The wrong incentives created by repeated surges of bold government action pose risks that have direct, short-term impacts, which we fear have been seriously underexplored during both the end of the Bush administration and the beginning of the Obama administration. We hope that, by pointing out these risks, they can be significantly mitigated at relatively low cost.

We begin by recommending a change to the general approach: halt soon the introduction of new, bold programs. We are not saying that nothing should be done; we are saying that it is important in times like these for government to reach closure on its decisions so that it can pick one set of rules of the game and then stick to them. We then focus more narrowly on the process of structuring workouts from bad deals and recommend avoiding approaches that undermine bankruptcy. Bankruptcy allows the large group of private professionals who are experts at restructuring or winding up bad deals - consultants, financiers, lawyers, managers, and so on - to get involved. Given the magnitude of the problem of toxic assets, any solution to the current crisis will almost certainly need to involve these private actors. We then explore how particular reform proposals can be implemented without running afoul of the cautions that are the focus of our effort. In the final analysis, we applaud the Herculean efforts by so many serious thinkers in the Bush and Obama administrations and outside government who have thrown themselves into this important work in good faith and with great sacrifice. All we can hope to add to the conversation are these relatively easy-to-deploy (and important to deploy quickly) tools for mitigating some vital but underappreciated risks with proposed financial system fixes.

Suggested Citation

Haber, Stephen H. and Kieff, F. Scott, Wrong Incentives from Financial System Fixes (October 31, 2009). REACTING TO THE SPENDING SPREE: POLICY CHANGES WE CAN AFFORD, Terry L. Anderson and Richard Sousa, eds., Hoover Institution Press; Stanford Law and Economics Olin Working Paper No. 383. Available at SSRN: https://ssrn.com/abstract=1496584

Stephen H. Haber

Stanford University - Hoover Institution and Political Science ( email )

Stanford, CA 94305
United States

F. Scott Kieff (Contact Author)

George Washington University - Law School ( email )

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Stanford University - Hoover Institution on War, Revolution and Peace ( email )

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McKool Smith ( email )

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HOME PAGE: http://https://www.mckoolsmith.com/professionals-Scott_Kieff

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