Tyler Cowen has some perceptive comments on my posts on financial regulation. As he says, the social cost of leverage is higher than the private cost, so regulation makes sense. But there are limits to this observation. The social cost of my murder is probably higher than the private cost too, but I nonetheless have all the incentive I need to avoid it. It's probably better to ensure that the private cost of over-levering is very high than to develop ex-ante regulation to prevent it.
Is it high enough now? Well, the CEO's of Merrill and Bear are out, but the CEO of Lehman is still in. Yes, they are still rich, but at that level of performance, the money is not important of itself; it is a way of keeping score. How much money would compensate Paul Krugman for being drummed out of his profession in disgrace?
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