Frequency and Severity of Recent Essay

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Economists call this 'moral hazard,' where individuals have an incentive to behave recklessly because they know they will not be punished for their mistakes" (Interview, Der Spiegel, 2009).

The obvious response to such allegations is that the failure of Lehman Brothers which precipitated the collapse of the world's markets indicates what can transpire when something that people expected to be backed by a government is allowed to flounder. Lehman felt certain that the U.S. government would and could bail it out, just as it had similar companies in the past. Now the government is afraid NOT to extend aid to failing institutions, given what transpired post-Lehman.

So the cycle continues -- assurance of no need to suffer moral hazard results in a collapse of an industry (or government), the institution is shored up because it is too dangerous to let it fail, which results in the revivification of a dangerously reckless organization that goes back to its old ways, once regulatory constraints are removed after its financial recovery. But the IMF defends its policies "From a moral hazard perspective, it may be the right decision to allow a bank to fail. But the systemic consequences have to be taken into account and in this case they have been severe. I think most people today would say that letting Lehman go down was not a good idea," as the damage can be so catastrophic to innocent workers and citizens who had nothing to do with the machinations behind the crisis (Interview, Der Spiegel, 2009).

It is fair to say that even though its current lending program is controversial, the IMF has not only offered loans to failed governments and other institutions -- it has also been heavily critical of low capital requirements that continue in financial sector and called for them to be increased (Interview, Der Spiegel, 2009).

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Capital requirements act as a kind of insurance, in the wake of a sharp financial downturn. But even urge to increase foreign reserves at the bank is not a deviation in IMF policy, or a unique response to the current crisis: "Emerging market reserves rose steadily over past decade," in many cases with the specific intention of preventing a crisis (Foreign reserves, IMF Survey, 2009). Self-insurance does not seem successful: while the global economy may weathered the current crisis better than in the past, this may have more to do with increased government controls and regulation, in comparison with the 1930s. "There is no apparent relationship between the amount of reserves held before the crisis (scaled by the size of the economy) and output declines during the crisis…. [thus there is] no clear evidence that large reserves have lowered output declines" (Foreign reserves, IMF Survey, 2009). To make one point of comparison: "Brazil has much higher reserves than Mexico, even relative to the size of the economy, there has been very little difference in the performance of credit default swap spreads" (Foreign reserves, IMF Survey, 2009).

The IMF's new lending instruments and demand for nations and institutions to increase reserve accumulation thus remain questionable in their ability to forestall the possibility of such a crisis occurring again. To some extent, the IMF has a limited ability to change the regulatory policies of other nations, although it has criticized U.S. internal policy regarding the regulation of its banking sector. IMF's generosity in extending loans to struggling nations is an illustration, in theory, of the ways moral hazard can be circumvented in cases of risky speculation and deregulation. The IMF is hardly to blame for the crisis, but neither has it pursued an aggressive and innovative role in preventing such a crisis from reoccurring.

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