Are we headed for another economic big bang?

This offsetting of risk is known as moral hazard. What lies at the core of the global debt crisis is the "too big to fail" syndrome. There have been other financial crises since the advent of the debt crisis such as the Savings and Loans crisis, the Asian financial crisis as well as a few others smaller in scale.  These were not truly global although perhaps we could argue the point on the Asian crisis. Again moral hazard loomed large in all of these.

In the wake of the current global financial crisis we are told that regulators will address moral hazard. Surely only the wayward Electric Monk of Dirk Gentley's Holistic Detective Agency could possibly believe that.

Consider for instance Barack Obama's financial industry friendly toxic asset relief program. The best characterisation of this is due to Joseph Stiglitz who called it "ersatz capitalism". Stiglitz reveals that, "What the Obama administration is doing is far worse than nationalization: it is ersatz capitalism, the privatizing of gains and the socializing of losses" which has "perverse incentives, worse even than the ones that got us into the mess".

Moral hazard is very important for the future given that GFC 2.0, to a very significant extent, can be described as a global market failure arising from a global externality. Crucial to the development of this externality was the under pricing of risk by financial institutions. That is to say, systemic risk was under priced from the point of view of society. From our perspective rational financial market entities took on far too much risk, enabled by both deregulation and lax regulation, in the pursuit of dazzling short term profits.

Whenever we have moral hazard systemic risk will be under priced by financial markets. It seems that future regulatory reforms won't have many teeth. One important measure would be the break up of the large financial institutions. For instance, we might once again seek to separate run-of-the-mill banking from investment banking. However, the British Prime Minister, Gordon Brown, has rebuked the head of the Bank of England, Mervyn King, for suggesting this.

You just know that we have come to a pretty pass when the Bank of England lies to the Left of the Labour Party.

Recognising the presence of an externality does not necessarily tell us much about its underlying cause. The best causal explanation that accounts for GFC 2.0 is the Post Keynesian financial instability hypothesis of Hyman Minsky. The current crisis is an example of "debt-deflation". We should not place too much store on the "global imbalances" theory. One of the purposes of a well designed and regulated financial system is to manage imbalances in savings.

One important facet of Minsky's work concerns what he called "financial simplification". Measures put in place to avoid a repeat of the Great Depression given financial instability effectively set up conditions for the next crisis, possibly leading to a series of crises of increasing severity. This is because in a depression scale contraction excessive debt is wiped out hence leading to "simplification" as financial markets become correspondingly less complex.

We were indeed headed for a Great Depression era level contraction this time but for a whole raft of globally co-ordinated government measures that were truly grand in scale.

But are these measures in fact setting us up for a bigger bang given the absence of simplification? The most important thing to do now is to lower private debt levels, which are far too high. Public policy should be directed towards facilitating this. Good high paying full time jobs developed through a strategic industry policy would help by boosting incomes. Greater consumption should be a function of wages growth not rising debt and property bubbles.

Debt-deflation in the US has had class war right at its core. Since the 1970s real wages for non-supervisory workers have largely been stagnant, despite rising labour productivity. Workers are more productive but the proceeds have gone to the rich. In order to maintain the American dream US workers have relied upon a mountain of debt.

But the Henry debate suggests that our focus should be elsewhere for it's all about what to do with the boom which is but around the corner, if not already underway.