Ben Bernanke is giving a speech at Morehouse College right now. Unfortunately, there is little chance he’ll address one of the most pressing challenges we face.
The topic of a number of Bernanke and Geithner’s recent speeches is how we can create a financial system characterised by prudence and efficiency. This includes the idea that the great challenge is designing a regulatory regime under which large, complex financial institutions will no longer be at risk of massive failure. The solution he favours involves a better regulatory regime that can successfull monitor risk, which is a little like a drunk trying to solve the problem of spending all his money on booze by favouring rivers made of whiskey. Might be nice but it aint gonna happen.
Instead, we need to flip the question. Instead of scheming in vain for a financial system in which failures don’t happen, we need to rebuild a system in which failures will be permitted to happen. That is, we need to build a system of resolving failures rather than attempting avoid them. Failure has an important role to play in the market, and we’re damaging the markets by discounting failure.
So let’s get started. How do we restore failure to its proper role in the financial markets?