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Unlimited Liability, Contingent Capital and Living Wills

Mankiw argues that if federal authorities assume responsibility, the entire financial system might well become a group of government-sponsored enterprises.

Question:
A) Explain how preventing the impact of systemic risk creates a financial sector dominated by government-sponsored enterprises.
B) Evaluate the practicality and effectiveness of proposals such as: Moving towards unlimited liability; the provision of contingent capital and living wills.

Solution Preview

It took me a little while to find it, but the text you're referring to was a 2010 column that Mankiw wrote for the New York Times.
It's here:
http://www.nytimes.com/2010/03/28/business/economy/28view.html
(This is the main article in question, but there are others)

And here's another, older, piece dealing with Mankiw's views on GSEs (Government Sponsored Enterprises).
http://www.marketwatch.com/story/bush-adviser-warns-of-fannie-mae-freddie-mac-risks

And his remarks on GSE's in 2003:
http://scholar.harvard.edu/mankiw/files/stbank.pdf

So the questions:
A)Explain how preventing the impact of systemic risk creates a financial sector dominated by government-sponsored enterprises.

B)Evaluate the practicality and effectiveness of proposals such as: Moving towards unlimited liability; the provision of contingent capital and living wills.

Remember, at Brain Mass, we cannot answer the questions directly, but we can give you a bunch of ideas as to how you can put together your own answer.

The above are complex questions, and Mankiw has a set of fairly complex answers. He is against the creation of a GSE, but in favor of preventing undue risk. Many of his predictions on the mortgage market turned out to be true. Mankiw does NOT hold that preventing risk with government oversight will lead to the creation of a GSE, but it can. The real variable is whether or not the regulators will have access to government money. He did believe that the structure of the GSE in the early 2000s was leading to a disaster.

Several issues need to be mentioned in your answer from the above text:

He is clearly against the government sponsored enterprise (specifically here Fannie Mae and Freddie Mac). Here, private capital is more or less 'backed' by the federal reserve and the bankers who run it (or at least there is a perception that this is the case). Mankiw ...

Solution Summary

The expert explains how preventing the impact of systemic risk creates a financial sector dominated by government-sponsored enterprises. The unlimited liability, contingent capital and living wills are determined.

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