December 08, 2014

A regulatory guiding hand poses great systemic risks, and often doubles down on its mistakes, like with Basel III.

Sir, I refer to Mark Vandevelde’s “Beware the paternalist in libertarian garb” where December 8 he reviews Cass Sunstein’s book “Valuing life: Humanizing the Regulatory State”.

Vandevelde finalizes the review championing regulation and writing: “Better to acknowledge out loud that, on life’s dark prairie, the torch of freedom is something less useful than a guiding hand”.

Of course that might be true, in some cases, but at the same time he should acknowledge that a guiding hand has immensely larger possibilities to introduce dangerous systemic risks than any free market.

Just look at bank regulators who, to how banks respond to perceived credit risks by means of interest rates, size of exposure and other terms, added on their basically similar response, to the same perceived credit risks, by means of their credit risk weighted capital requirements for banks. And that of course distorted all the allocation of bank credit to the real economy.

It is ok to use the average risk aversion of nannies, that is what the market usually does, but it is sheer lunacy to add up risk aversions, which is what the Basel Committee did.

And when the market gets it wrong, it feels the pain, and it fast corrects itself; but, when regulators get it wrong, they quite often suffer no consequences, and so double down on their mistakes… like with Basel III following Basel II… and keeping credit risk-weighting as a pillar.