December 14, 2012

Bailouts and the socialization of losses is not the responsibility of banks but of governments, and what banks really must do, is to relearn the ancient art of lending to “The Risky”

Sir, James Grant writes “Banks need to rediscover the ancient art of caution” December 14, and mixes up any ex-ante behavior of banks, which is their responsibility, with the ex-post socialization of their losses, which is entirely the responsibility of governments. 

Also, were not our current predicaments so sad, it would almost be funny when Grant preaches “A good banker lent against the collateral of short-dated commercial bills, not heaven forfend-property”, and as if implying that the banks had been out on a very risky bungee-jumping tour. 

Does Grant really believe that holding triple AAA rated securities backed with mortgages, and to which the banks were authorized by their regulator to leverage their equity 62.5 to 1, so safe were these, and for which there was an immediate mechanism to obtain liquidity by selling these in a market that very much demanded these securities… evidenced a lack of caution? Is it not an excessive regulatory risk-adverseness against all perceived as “The Risky” and which drove the banks excessively into the arms of “The Infallible”, precisely the spot where all bank crises have always originated. 

No, the problem is that bank regulators, with their capital requirements based on perceived risk, gave the honest bankers an additional motif to behave just like Mark Twain describes them, namely those who lend you the umbrella when the sun shines and want it back when it looks like it is going to rain. And as a consequence banks got caught with excessive exposures to “The Infallible” with no capital at all. 

On the contrary, what bankers must now with urgency relearn, is the art of lending to “The Risky”, like unrated small businesses and entrepreneurs but, for that to happen, we first need to rid ourselves of nervous regulatory nannies who want banks to deal exclusively with “The Infallible”, triple-A rated and sovereigns (like Greece).