April 06, 2014

We must stop bank regulators from building a long-term jobless trap

Sir, a banker stands in front of two doors, one is “the infallible” the other is “the risky” Until not so long ago he would take any of the doors which provided him with the highest expected risk adjusted return on equity, considering the interest rates, the size of exposure and all other contractual terms.

Not any longer. After regulators, with their risk based capital requirements, allowed the banker to put in much less equity when he opened “the infallible” door than when he opened “the risky” door, very rarely does he enter the risky door, because very rarely will those behind that door be able to provide him with risk adjusted ROEs as high as those borrowers behind “the infallible” door.

And unfortunately the truth is that much, or perhaps even most, of that kind of sheer dumb luck the economy must have in order to find new long-term employment opportunities, hides behind “the risky” door.

And that Sir is what I most miss in Tim Harford’s “The long-term jobless trap” April 5. If you allow bank regulators to introduce dumb and almost sissy risk aversion into the banking sector, you are actually allowing them to build a long-term jobless trap… where many are bound to fall into, sooner or later.