Professor Hubbard, bad news, the waters you fondly remember, have been contaminated by bank regulators

Sir, Professor Glenn Hubbard wants the US to walk down a narrow path, carefully avoiding the fiscal cliff, so as to reach the “pleasant waters [with] less uncertainty and stronger growth, “How the US should avoid falling off the fiscal cliff”, November 13. And, in doing so, he suggests that the US avoids increasing marginal taxes, which “distort behavior and reduce activity” and go for scaling back tax deductions instead. 

I completely agree with Professor Hubbard, but I have some very bad news for him. Those waters that he so fondly remembers from his youth are not the same waters anymore, they have been contaminated. 

When bank regulators decided to allow banks to hold much less capital against exposures to “The Infallible” than against exposures to “The Risky”, and thereby allowed “The Infallible” to provide the banks with a much higher risk-adjusted rate of return on equity than what “The Risky” could do, they effectively made the banks much more risk-adverse than what they already were. 

And banks, as a consequence, abandoned taking on the traditionally manageable risks we need them to take on, like lending to small businesses and entrepreneurs, “The Risky”, and entered a suicidal path of taking unmanageable exposures to “The Infallible”, and precisely the kind of exposures that have always resulted in a lot of tears. 

And so Professor Hubbard, if you do not want to be unpleasantly surprised when reaching the waters, ask your bank regulators to immediately stop discriminating in favor of those already favored by markets and banks, and against those already discriminated against. 

It is none of a bank regulators’ business to distort the economic resource allocation function of our banks, only because full of hubris they want to fool around playing risk managers for the world. In fact, and as I have said it before, if these bank regulators had done what they did knowingly on purpose, that would represent an act of high treason against our economies, and for which they should be shot.