November 02, 2012

The Martin Wolf Inconsistency

Sir, Martin Wolf ask for “Radical policies for rebalancing Britain’s economy” November 2. In it he again favors the government to be less austere, “the case for a reconsideration of fiscal policy remains strong” and the banking sector, even though loans have contracted immensely, to be more restricted, “the case for much lower leverage is far stronger than in normal times”. Why the inconsistency? The only explanation possible is that Wolf is a firm believer that government spending allocates the resources with more economic efficiency than what banks with their credits can do. 

And yes, in many ways Wolf is correct, because regulators, by means of their capital requirements for banks based on ex ante perceived risk, exerted so much influence favoring “The Infallible” and thereby discriminating against “The Risky”, that the banks have indeed not allocated their credits in an economic efficient way. But, the solution for that should be less government intervention, not more! 

“Rebalancing?” Yes! But, Sir Mervyn King, how about rebalancing first between “The Infallible” and “The Risky”?

In this respect, for the umpteenth time, Wolf would say “monotonously”, I hold that one of the most important challenges for the UK, Europe and America, is to work themselves out of that silly bank regulatory risk-aversion, which caused and causes the banks to dangerously overpopulate safe-havens and, equally dangerous, at least for the society and the economy, to under exploit the more risky but more productive bays, like small businesses and entrepreneurs. 

Martin Wolf, when he writes “Equity targets [for banks] should be set in pounds”, and although he probably loathes admitting it, shows that he finally begins to understand how the capital requirements for banks perceived on risk distorted the economy,. 

Unfortunately, to get rid of those distortions is not as easy as Wolf would like it to be, in order for that issue to go away fast. You simply cannot attract the so much needed new bank equity, by introducing prohibitions to pay dividends subjectively set by regulators. You need to design a credible transition plan so that any new bank investor knows what he can expect tomorrow. And, to do that, you need to put at work fresh regulatory minds not encumbered by past mistakes. 

And so, before messing with tools like depreciating a currency (buying foreign low-risk assets?), in a world were so many currencies wish for depreciation, I suggest that UK, America and Europe draw up a careful plan, acceptable to future bank investors, for how to allow the banks again to take a chance on “The Risky”, those that in truth made the UK, Europe and America what they are. 

To me that plan should pursue making banking more of a safer and lower rate of returns utility, and so able to attract more widows and orphans like funds. For the rest of the economy to prosper, we must make banks be a lower returns affair.