How to Contain a Financial Crisis Without Bailouts


383 Madison Ave Bear Stearns C R Flickr 3

383 Madison Ave Bear Stearns C R Flickr 3 (Photo credit: Wikipedia)

By Bruce Tuckman – Four years after the fall of Bear Stearns our fallback policy in a crisis is just as it was in 2008: rely on emergency, ad hoc lending by the Fed. We should not settle for this approach. We can break the cycle of boom for the financial industry and bust at the risk or expense of taxpayers by creating a credible, ex ante, and market-oriented policy of providing liquidity in a crisis.

A low-risk alternative would be to have the Fed auction a new instrument — the Federal Liquidity Option (FLO) — as the exclusive means of lending money to non-banking financial firms in a crisis. (Banks can borrow from the Fed at any time through the “discount window.”) A FLO would give its holder the right to borrow a fixed amount of money from the Fed at a predetermined rate of interest and under prearranged collateral terms.

We will never succeed in eliminating financial crises. By pre-committing to a fixed and credible policy of providing liquidity in a crisis, we can eliminate bailouts, rescues, and moral hazard. more> http://tinyurl.com/6unbu6x

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