July 13, 2015

Are bank regulations and their effects something that is beneath the dignity of financial academicians to study?

Sir, Lawrence Summers writes: “The financial crisis, the great recession and sharp increases in inequality have all properly led to a negative reassessment of the functionality of unfettered free markets.” “Complacency and incrementalism are traps to avoid” July 13.

That is because he, as most of economy/financial academicians, have not had any interest in studying what bank regulators have been up to. Had they done so, and had they understood how current credit-risk-weighted capital requirements for banks distort the allocation of credit to the real economy… they would not speak of “unfettered free markets”… that is unless it is part of their political agenda.

Basel Accord of 1988 indicated risk weights of zero percent for loans to OECD governments and 100 percent for loans to the private sector. That translated into allowing banks to leverage over 60 times when lending to governments and only about 12 times when lending to the private sector. “Unfettered free markets”? You’ve got to be kidding!

Let us break down the components:

1. The financial crisis: All bank assets that turned into major problems had in common that regulators allowed banks to hold these against very little equity.

2. The great recession: Since regulators require capital scarce banks to hold more equity against loans “the when the going gets tough the tough gets going” SMEs and entrepreneurs than against “safe” assets… there is no chance to get out of the recession in a sustainable way.

3. Increases in inequality: By banks, because of these capital requirements, negating opportunities to “the risky” inequality must prosper.

I rest my case ... at least for some minutes J