It seems like thinkers on the left like Matthew Yglesias and on the right like John Cochrane have been taken in by the argument presented in "The Banker's New Clothes", which professor McKinney mentioned in class. It seems like the core of the argument is that because the government subsidizes bank debt both implicitly through bailouts and in some explicit ways, banks (surprise surprise) take on too much of it. The solution: stricter capital requirements.
Cochrane lays out the book's case well, writing:
"More capital and less debt would stabilize the financial system in many ways. If a bank wants to rebuild its ratio of capital to assets from 1% to 2% by selling assets, it has to sell half of its assets. Doing so can spark a fire sale, especially if all the other banks are doing the same thing. If the same bank wants to rebuild capital from 49% to 50% of assets, it only has to sell 2% of its assets."What I like best about this argument is that it focuses on what economics can understand and do something about: incentives. The documentary we watched, while interesting, seemed intent on focusing on some moral element of the financial crisis. There were villains who frequented brothels and bought expensive jets while crashing the economy, and there were noble heroes who could've saved us if only we'd listened!
I'm not so convinced, and it seems to me that this is a problem of incentives. If we're going to subsidize bank debt, then it makes sense to control how much debt banks can have. That seems more productive than wishing bankers were less greedy or trying to enforce 3,000 more pages of regulations.
I completely agree here; it is all about incentives. Our culture allows for money and profits to rule and the incentives that are in place help create this culture. If the government actually wants to do something about the banks and the seemingly lax morals of companies and executives they have to change incentives. I think executive salaries may be a place to start. It's an incredibly complex issues but I think we've gone past the incentive to do well and work hard and gotten into the incentive to exploit and take advantage of people with the millions of dollars these people earn. The value of money is completely distorted with these executives so playing with large amounts is easy and creates a higher degree of risk. this might be a place to start, but it is an incredibly complex issue so I cannot claim that salaries would fix it.
ReplyDeleteIt would make sense to control how much debt banks can have. And like the article says, "Guaranteeing debts creates perverse incentives, so our government tries to regulate the banks from taking excessive risks." Abby is right about where our incentives have shifted. Banks should raise more capital, but I don't see the government doing this.
ReplyDeleteI think that this sort or regulation is do-able. I know that the left would be all for it, but I think the right would honestly consider this sort of policy. It really isn't as restrictive on the economy as other regulatory laws. Here they are just attacking the financial industry, which although has a huge roll in the overall economy, we have shown in the past can survive without the absolute power it controls now.
ReplyDeleteGoing back to Quiggin, I agree with much of what has been said and think that Quiggin has some interesting ideas about the shifting of risk in financial markets. Regulations or structural reform might be influenced by that crash like in America post-depression. Public/ institutions were more cautious in the financial management of assets. I think Philip is correct in not making this a moral argument against individuals but a more institutionalized issue in the system.
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