Freedom Line Blog

After an erratic end to last week’s trading filled with ‘typos’ and frozen stocks, the Dow and markets all over the world are rallying on news that the European Central Bank will create a trillion dollar fund to buy government and private debt to keep lending liquid.  With the help of the IMF and the Euro-using nations, the fund will prop up troubled governments.

The response of surging stock markets does not mean this is a wise and sound policy.  Investors merely feel the momentary comfort that there will be enough stability in the short term for money to be made.  But this plan is little different from the $50 billion rainy day bailout fund batted around the debate for financial reform here in the United States, other than the sources of funding.

Such measures create perverse incentives for market actors, whether a country like Greece, or private firm like Goldman Sachs, saying, “Go ahead, and continue to take big risks.  Don’t worry about the consequences.  We’ve got your back.”  Why should Greece tackle its massive public sector union crisis?  Why wouldn’t Wall Street firms go out on a limb for a big potential gain, if there were a multi-billion dollar bailout fund to catch them if they fall?

Markets are all about incentives.  Rainy day bailout funds create the wrong incentive.