Fed Governor Tarullo on TBTF and Regulatory Failures *Yawn*
Haven't we heard this speech a bazillion times already? Yeah yeah yeah, Tarullo, tell us something we don't know. It's as if all the Fed has these days is exit strategy blah blah blah, TBTF must be stopped blah blah blah... isn't there anything else interesting going on over there?
Anyway, Tarullo on moral hazard to the Exchequer Club, Washington, DC:
Moral hazard is, if not quite pervasive, certainly common in modern economic life. The best evidence that we are willing to live with some degree of moral hazard may be found in the importance of insurance as a social institution. The costs that would be incurred in trying to eliminate moral hazard completely from, say, a casualty insurance policy are simply too high as a practical matter. Similarly, we should not realistically expect to eliminate moral hazard completely in the financial sector. What we can reasonably expect and, indeed, should insist upon, is that we take steps to contain the problem such that the social costs associated with the consequences of the misaligned incentives do not exceed the benefits associated with the operation of the institutions or markets in which the moral hazard exists.
Parallel reasoning applies with respect to the negative effects that may attend the failure of a large financial institution. Efforts should be made to reduce those effects, but in such a way that takes account of the costs that these efforts may themselves impose on productive activities. In the financial arena, the trade-off is often characterized as one between the availability and efficient allocation of credit, on the one hand, and the safety and soundness of the financial system on the other.
The conventional response to moral hazard problems arising from anticipated government support for financial actors has been to enact regulation to counteract unwelcome effects on the incentives of creditors, investors, or managers. Thus, for example, the potential moral hazard arising from the availability of discount window lending or from the presence of federal deposit insurance is offset to some degree through safety and soundness regulation. Likewise, the potential for large negative externalities from a firm’s activities is often countered with regulation designed to force some measure of social cost internalization by the firm.
A regulatory response for the too-big-to-fail problem would enhance the safety and soundness of large financial institutions and thereby reduce the likelihood of severe financial distress that could raise the prospect of systemic effects. Such a response consists of three elements.
And then there's some crap in there about TBTF but it's nothing we haven't heard before. Tarullo has sure been yapping a lot lately, what gives?