What Banks Do

I am certain it is true that the nonfinacial sector would love to hold short-term risk-free assets, especially if they pay a high return. It is also true that businesses that invest in real projects and seek to minimize financial risk would prefer to issue long-term liabilities that try to match payouts to lenders with expected project cashflows. However, this gap is not, in fact, intermediable. An intermediary that claims to offer truly riskless assets against investments in risky projects must rely upon subsidy, subterfuge, or both.

via Interfluidity :: A think-nugget from Arnold Kling inspires a very long riff….

You might think this duller than dirt, but the quoted article provides a wonderful overview of banking in the larger context of society. It also provides insight into what really could be done to prevent financial blow-ups such as we’ve seen. All this is unlikely to happen, but if you want to understand banking in the larger context, this is a must read.


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