As we have noted often, in tightly coupled systems like our modern financial regime, efforts to contain risk typically make matters worse. As Richard Bookstaber explained in his Demon of Our Own Design, there are two reasons for this phenomenon. First is that processes move through a series of steps that cannot be interrupted, so certain interventions are impossible short of shutting down the entire system (or a fundamental redesign). Second is that any intervention cannot be localized. It inevitably produces other effects that are at best unintended, and generally not neutral.

The latest illustration: one of the big motivations behind the latest “let’s save the banks” initiative was (first) to get interbank lending going, but a second, important goal was to facilitate mortgage lending, with the hope that volumes would improve, and even better yet, rates.

Unfortunately, in another example of unintended consequences, the improvement in interbank lending in occurring at a glacial pace, while mortgage rates went in the wrong direction, and quickly to boot.

From the Financial Times: