Rogoff on financial sector excesses

I came across this article by Ken Rogoff where he also talks about the growing excesses of financial sector and the need to prune it down. (Thanks to Naked Capitalism for the pointer). I had earlier pointed to Solow’s and various other views as well.

The idea that the world’s largest economies are merely facing a short-term panic looks increasingly strained. Instead, it is becoming apparent that, after a period of epic profits and growth, the financial industry now needs to undergo a period of consolidation and pruning. Weak banks must be allowed to fail or merge (with ordinary depositors being paid off by government insurance funds), so that strong banks can emerge with renewed vigour.

If this is the right diagnosis of the “financial crisis”, then efforts to block a healthy and normal dynamic will ultimately only prolong and exacerbate the problem. Not allowing the necessary consolidation is weakening credit markets, not strengthening them.

After a period of massive expansion during which the financial services sector nearly doubled in size, some retrenchment is natural and normal. The sub-prime mortgage loan problem triggered a drop in some financial institutions’ key lines of business, particularly their opaque but extremely profitable derivatives businesses. Some shrinkage of the industry is inevitable. Central banks have to start fostering consolidation, rather than indiscriminately extending credit.

It is time to take stock of the crisis and recognise that the financial industry is undergoing fundamental shifts, and is not simply the victim of speculative panic against housing loans. Certainly better regulation is part of the answer over the longer run, but it is no panacea. Today’s financial firm equity and bond holders must bear the main cost, or there is little hope they will behave more responsibly in the future. 

Rogoff’s words matter as he has done loads of research on financial crises He is a leading economist on issues related to macroeconomics and financial markets. He would most likely be disappointed as authorites are busy with one intervention after the other leading one bail-out to another.

2 Responses to “Rogoff on financial sector excesses”

  1. Quantifying financial sector excesses « Mostly Economics Says:

    […] have been number of comments on the financial sector excesses in US. So much so, economists like Rogoff have said it has to shrink. I have myself written a number of posts on the financial sector […]

  2. Financial Oligarchy at its best « Mostly Economics Says:

    […] in developing economies. However, the recent developments and comments from top economists (Solow, Rogoff)  made me write a post whether this political economy is […]

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