How Not to Solve a Crisis

…is the title of a useful contribution to the discussion from the International Policy Network in London and the Lion Rock Institute in Hong Kong. Their recommendations for finding a way out of the financial mess are worth attending to:

– Better mechanisms are needed to manage the failure of large financial institutions, some of which may now be both too big to fail and also too big to rescue.
– Open ended guarantees to depositors and other counterparties are expensive and unsustainable in the longer term.
– The rights and hierarchy of investors across the capital structure should be clear and honoured — not subject to arbitrary alteration by government.
– Closer attention to the rights of collateral providers and custodians in the case of failures can limit systemic risks.
– Hedge fund failures have not created systemic risks in this crisis and they should not be a target of policy action.
– Ad-hoc bailouts should be avoided, since they create ever expanding demands for further intervention.
– Much more thought needs to be given to the unintended consequences of over strict capital rules, rating agency privileges and rating based limits on pension investments.

As the authors say, “free markets thrive on creative destruction” and these recommendations would help in that respect. In fact, when it comes to free markets, creative destruction isn’t a bug. It’s a feature!