January 22, 2010

Regulations should not confuse the market.

Sir you say in “A declaration of war on Wall Street”, January 22, “The government’s key policy lever should be to make sure that institutions hold enough capital to reflect the risks that they run and the threats that they pose to the rest of the financial system.”

You are right about “enough capital” but very wrong when you expect these “to reflect the risks” because that is exactly how you drag the regulator into the type of risk discrimination game that provided the wrong set of incentives by artificially increasing the attraction of the AAA rated instrument and which led to the current crisis.

Set a general capital requirement for all type of activity of banks, which could fluctuate somewhat depending upon where in the economic cycle we find ourselves, and then let the market act upon that. Do not allow the regulators to confuse the market with their risk discriminations.