September 21, 2012

Our economies, now turning very flabby, will soon fall into a permanent falsetto... unless

Sir, in Martin Wolf in explaining “The puzzle of the UK´s falling labour productivity” September 21 advances the possibility of one cause, suggested by Ben Broadbent of the Bank of England’s Monetary Policy Committee, namely that of “misallocation of capital dues to a defective financial system”. Wolf accepts it but does not believe it to be very important. 

Of course, if he cannot get a grip around the concept that allowing banks to leverage their equity more when lending to the “not-risky” than when lending to the “risky” introduces incredible distortions in the economy, and guarantees a flabby economy, he cannot think of it as important. 

The fact though is that funds are flowing to what is perceived as safe, and away from what is perceived as risky, in all Western economies, as a consequence of mindboggling stupid bank regulations. 

In this context, the small efforts to make up for the failings, like the one Wolf states he has proposed, namely that the government should insure the tail risk on bank lending to small and medium enterprises, are almost laughable. What he actually saying is that, insure the tail risk for these risky borrowers and then you might define them as “not-risky” and allow them access to bank credit in the same terms as those currently considered as “not-risky”. And that is not the way to go about correcting the mistakes made. 

Our economies, UK’s included, are castrated by the capital requirements for banks based on perceived risks, and, if nothing is done urgently about that, they might soon fall into a permanent falsetto.

PS. For the benefit of those who like Martin Wolf do not get it, I am trying to put together an introductory course, a 101, on the issue of Stupid Bank Regulations