Saving Capitalism from Catastrophic Meltdown

The University of Chicago's Raghu Rajan says the free market pendulum is in danger of swinging too far and that government regulation is needed to reduce the chances of a catastrophic meltdown:

U. of C. star economist says risks call for, yes, regulation, Raghu Rajan, on loan to IMF, says likelihood of meltdown grows, by Greg Burns, Chicago Tribune [Note: We have link rot, this is the best alternative]: These are quiet times in the global economy, just the sort of lull that worries Raghu Rajan, one of the University of Chicago's leading stars. On loan to the International Monetary Fund, ... the 42-year-old native of India sees risks on the rise in housing markets, hedge funds, pensions ... Difficult to track and often disguised, the steady accumulation of risks has increased the odds of what Rajan cautiously terms "a greater (albeit still small) probability of a catastrophic meltdown."

A sharp decline in home prices, for instance, could cripple the job market, trigger loan defaults, hurt anyone invested in mortgage securities, and eventually undermine every moving part of the interconnected financial system. "When you've let down your defenses, things can come and smack you," Rajan explained ...

Rajan is no Dr. Doom. His sophisticated ideas have won him the respect of the world's most rigorous financial experts. Yet he is convinced that years of easy credit and the rapid expansion of financial markets have left little cushion if things go wrong. "We haven't had a real storm in the financial markets since 1987," he said. "The cost of this thing could be tremendous if it turned out the wrong way."

What to do? Surprisingly for a dedicated advocate of free markets in the University of Chicago tradition, Rajan believes more government regulation is needed. After decades of deregulation and laissez-faire policies, "We are in danger of the pendulum swinging too far," he said. "The times have changed." ...

There is quite a bit more in the original article.