Deconstructing the Put-Option State

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4 Responses

  1. Frank says:

    These are all excellent points. Charles Morris’s Trillion Dollar Meltdown tells a similarly sad tale (at 153):

    “Martin Wolf, the economist and commentator for the Financial Times, recently noted that over the very long term, global financial services profits are about twice as high as those in the rest of industry. That runs counter to a fundamental proposition of free-market economics, that profits across enterprises should even out over time.”

    “The reason for the permanent advantage . . . is that they don’t really compete in free markets. . . . [I]n financial services, although the high profits accrue to managers and shareholders, their losses are usually partly socialized.”

    Given that this pattern of privatized profits and socialized losses appears inevitable given the power of the financiers, shouldn’t we limit leverage?

    I also agree with you on the need to change political culture. But if the Obama administration were to have “gone Swedish” (as Thomas Hoenig, President of the Kansas City Federal Reserve, has urged), it would have been slaughtered by the CNBC and Club for Growth crew. The name of the political game now is to avoid tripping on certain words….”socialism” is the preferred cudgel for the right, just as “privatization of Social Security” will be a cudgel of the left against entitlement reform.

    I also think that if Obama had liquidated and reorganized the zombie banks, the negatively affected financial potentates would have organized a massive, “Harry and Louise” style political campaign against him. The parallel to health care doesn’t end there…that’s also an industry riddled with fake competition and governmental favors. I predict you’ll see a banking industry that looks a lot like the health care industry in a few more years…except with no obligations to look out for the disadvantaged and elderly!

  2. Brian says:

    Is there any empirical evidence that then institutions that engaged in this self-destructive behavior did so believing and calculating that they had the political power to get a bailout if things went badly? This argument seems to be cut from whole cloth.

  3. David Zaring says:

    Nice post, and thanks for the kind words. I’ve got to say that I’m not totally sure that put options explain everything. Every shareholder in every one of these financial institutions wishes they hadn’t invested in those firms. They owned them, and they didn’t have a put option. So I think something else needs to explain why the owners of the firm failed to monitor their investments.

  4. Frank Pasquale says:

    DZ asks “why the owners of the firm failed to monitor their investments.” I have a sense that fraud suits like this one:

    will help answer that question.