“The inconvenient truth of financial crisis response is that the actions that feel right are often wrong […] The principles of effective crisis response are mostly counterintuitive. The more you commit to do, the less you’ll have to do.” – Stress Test, Timothy Geithner
I think it is, to an extent, logical to believe that during an economic crisis the first thing should be to stop whatever it is that is causing the crisis immediately and to directly “punish” , and certainly “not help”, the person/institution responsible. However, from a big picture view, according to those that have actually dealt with solving a crisis at a government level, it is likely that this can cause even more damage. Afterall, how does an economy recover if the credit markets are frozen and demand has collapsed?
In his book “Stress test”, Geithner offers a really interesting perspective. He comments that to stop a crisis, the government should lean against the forces of panic, acting in a way that makes it irrational to run. Disorganised failures of large institutions (Lehman for example and almost AIG) have the capacity to erode confidence in the market, pushing the economy into a deeper recession. He adds that the government should act to stop critical risk, to attract private capital, trying to avoid (more) bailouts that use tax-payers money. In other words, their response is a fight to make the market investable again.
In the US this was done by backing up investments, buying assets to inject liquidity with bailouts packages, by helping failing firms disappear (via an M&A at times) or restructure (all of which were deeply unpopular at the time!).
Governments and regulators have a very difficult and complex role where they have a need to think beyond politics and public pressure, thinking two steps ahead can sometimes not be enough. Overall, it’s a very interesting topic to think about!