I think Gary Gorton’s done the best work on the specifics of what, exactly, the financial panic of 2007-2008 was all about and the entirety of his Q&A with the Minneapolis Fed is interesting. But for now I just wanted to highlight this aside he offers about moral hazard:
It’s a similar thing with terms like “too big to fail.” The banking system was too big to fail. That’s why we allowed suspension of convertibility [in the 19th and early 20th centuries]. Suspension of convertibility by banks, prior to the Fed, was always illegal, but it was never enforced because nobody wanted to liquidate the banking system.
Which is to say, I think, that while moral hazard is an important phenomenon it also doesn’t really explain anything in particular. It’s always been there and probably always will be. What comes and goes is better and worse ways of dealing with it. The rise of the “shadow banking” sector meant we suddenly had an important slice of banking for which we didn’t have a good way of dealing with it.
Previous in TP Yglesias
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