Bloomberg has an editorial arguing that making banks boring won't prevent a crisis; only increasing bank capital will do so.
To the extent that its big point is that banks will suffer during an economic downturn and the only protection against that is more capital (or insurance, including from the government), it's hard to disagree. But what this editorial misses is that 2008 wasn't just some periodic economic downturn that occured for reasons beyond our comprehension or control, like El Niño and La Niña weather patterns. Instead, the 2008 financial crisis was made by the banks themselves. The 2008 financial crisis was the inevitable result of the financial services' industry's behavior in the 2000s. And that's why we have to make banking boring. Boring banks might be hurt by economic crises, but they don't make them. We cannot prevent every economic downturn, but there's no reason we should suffer the preventable ones.
So how is boring banking a solution? It matters for two reasons, one widely understood, and the second entirely overlooked.
First, boring banking does a reasonably good job of aligning risks and
rewards for the parties actually making loans, and this helps control
against asset price bubble. Boring banking, in its simplest, most
stripped down form means that banks make loans and hold them on their
balance sheets. (There are problems that can stem from this, namely from
the asset-liability duration mismatch, but that's another issue, and
the other banking crises cited by Bloomberg didn't pose systemic threats
like 2008.)
The primary reason that the banks ran into trouble in 2008 was not
because they were making bad loans that they held on portfolio. Instead,
they made bad loans because they knew those loans would be securitized.
The problem was that the banks then went and bought into those very
same securitizations, which they then used as collateral for their
short-term borrowings (such as repo), making them intensely exposed to
the performance of their MBS.To the extent that its big point is that banks will suffer during an economic downturn and the only protection against that is more capital (or insurance, including from the government), it's hard to disagree. But what this editorial misses is that 2008 wasn't just some periodic economic downturn that occured for reasons beyond our comprehension or control, like El Niño and La Niña weather patterns. Instead, the 2008 financial crisis was made by the banks themselves. The 2008 financial crisis was the inevitable result of the financial services' industry's behavior in the 2000s. And that's why we have to make banking boring. Boring banks might be hurt by economic crises, but they don't make them. We cannot prevent every economic downturn, but there's no reason we should suffer the preventable ones.
So how is boring banking a solution? It matters for two reasons, one widely understood, and the second entirely overlooked.
Read more: http://www.creditslips.org/creditslips/2012/06/making-banks-boring.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+creditslips%2Ffeed+%28Credit+Slips%29
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