A regulator’s rational risk aversion when mounted on top of that of the bankers, produces an irrational risk aversion

Sir, John Authers when commenting on Andrew Lo’s “Adaptive Markets” writes: “our susceptibility to judge risks incorrectly is rooted in the necessities of survival. Fear, our early warning system, makes us irrationally averse to loss. We run greater risks to avoid a loss than to make a profit. “An emotional way to look at market theory”

Indeed, just look at bank regulators.

Even though bankers, because of their rational loss aversion, never create excessive and dangerous exposures to something ex ante perceived as risky, the regulators, with their risk weighted capital requirements for banks, mounted their rational aversion to loss, on top of that of the bankers’, and so it all became an irrational aversion to loss.

If the father’s and the mother’s average risk aversion is used educating their children, these will turn out well. But, if it is the sum of the father’s and the mother’s risk aversion that becomes applied, then their kids are lost... they will dangerously go too much for what is safe, and dangerously too little for what is risky.

In other words, the efficient markets hypothesis, the rational utility-optimising “homo economicus”, has no chance of working efficiently when interfered by regulations produced by some hubris inflated homo distorters.

@PerKurowski

What brain made bank regulators commit their so expensive mistake?

Sir, Gillian Tett in “The unmasking of our inner reptiles in times of crisis” August 13, writes about Professor Andrew Lo, of MIT segmenting our brains in the reflexive “reptilian”, the emotional “mammalian”, and the rational “hominid”. Tett also quotes Peter Atwater with respect to that a present “sense of insecurity is fostering a wider, longer term shift towards ‘narrow’ horizons.

Our bank regulators, by focusing too much on bank borrowers’ current credit ratings, without caring a iota about what such excessive focusing could imply for the banks’ medium and long term exposures, clearly regulated using a very ‘narrow’ horizon. There is no doubt that such an expensive error must have sprung out from a deep sense of insecurity but, what is not entirely clear is, what brain of the regulators was responsible for it, the “reptilian” or the “mammalian”, as the “hominid” was clearly not.