Will Next Time Be Different?

CHICAGO – Carmen Reinhart and Kenneth Rogoff, in their excellent, eponymous book on debt crises, argue that the most dangerous words in any language are “This time is different.” Perhaps the next most dangerous words are “Next time will be different.”

These words are often uttered when politicians and central banks want to bail out some troubled segment of the economy. “Yes,” one can almost hear them saying, “we understand that bailing out banks will subvert market discipline. But you cannot expect us to stand by and watch the system collapse, causing millions of innocent people to suffer. We have to live with the hand we are dealt. But next time will be different.” They then use every tool they have to prevent economic losses on their watch.

The government’s incentives are clear. The public rewards them for dealing with the problem at hand – whether building levees to protect houses built on a flood plain or rescuing banks that have dodgy securities on their balance sheets. Politicians and central bankers gain little by letting the greedy or careless face the full consequences of their actions, for many innocent people would suffer as well. A sympathetic press would amplify their heart-rending stories of lost jobs and homes, making those counseling against intervention appear callous. Democracies are necessarily soft-hearted, whereas markets and nature are not; government inevitably expands to fill the gap.

To the extent that the rough justice meted out by markets or nature teaches anyone to behave better, it has consequences far beyond the horizon of anyone in power today. When asked to choose between the risk of being known to posterity as the central banker who let the system collapse and the intangible future benefits of teaching risk takers a lesson, it does not take genius to predict the central banker’s decision. Democracy tends to institutionalize moral hazard in sectors that are economically or politically important, such as finance or real estate, allowing them to privatize gains and socialize losses.