Bank Risk

Barry

The principle arguments against regulations in general are that the regulators don’t have superior knowledge, regulations add costs that we all pay, and that regulations can stifle innovation. True enough. But there are some regulations that work well. For example, we all drive on the right side of the road (at least in this country). There’s no particular advantage to this, but we all agree that it is beneficial for everyone to drive on the same side of the road. Sometimes stifling innovation is a good thing.

As Megan herself noted, Galbraith has argued that finance does not lend itself to innovation. Alll financial “innovation” is simply a variation of the old leverage problem. Sooner or later, leverage always fails. Once you get into the leverage business (which is what banks do), the only question is how much leverage do you take on? The more leverage you assume, the riskier it gets.

I find it hard to believe that there is a “correct” amount of leverage that regulators, or anyone else, could specify. But I would favor regulation that required better disclosure of leverage and risk. We allow people to participate in risk – we don’t restrict bonds to AAA ratings. And as we all know, the bond rating guys have a serious black eye now. They can be wrong, and they can be wrong in either direction.

You can’t regulate risk away. Even disclosure is problematic. I believe the oldest financial advice is the best. The oldest advice? Caveat emptor!

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One response to this post.

  1. The best way to describe what happened in the USA regarding regulation: In the 1960s & 70s, we went beyond reasonable regulation to excessive regulation. Government regulatory actions were too costly, too complex and too time consuming.

    We may have gone too far in the opposite direction. What was once excessive regulation has morphed into excessive Deregulation — not enough cops on the beat to insure law and order.

    That leads to excessive speculation, recklessness, and eventually, financial problems such as the housing collapse and the credit crunch.

    I wouldn’t mind so much except that I as a taxpayer am being asked to fund this reckless folly AFTER THE FACT.

    Hence, I am interested in making sure that some preventative measure insure we do not have to bailout the speculators the next time . . .

    Reply

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