January 23, 2016

Too much fighting for a safe haven dissipates its safety and turns in into a dangerously overpopulated haven.

Sir, Tim Harford writing on the “dissipation of economic rents” holds that “They’re frustrating, because value is being frittered away in the competition to secure them… the entire value on offer will be consumed by the race to grab it.” “How fighting for aprize knocks down its value”

How come it is seemingly so hard for Harford and other economists to apply the same concept to the “dissipation of credit safety”?

If regulators allow banks to hold less capital against what is perceived as safe, which means they can leverage more with these assets, and which means they will earn higher expected risk adjusted returns on assets perceived as safe than on assets perceived as risky … then they will hold more and more of safe assets perceived as safe… until the safety of these assets dissipates.

Harford asks: “Can anything be done about … rent-dissipating behaviour?” and answers “One approach is to tax it.” 

Since dissipating credit security is the result of a regulatory subsidy in favor of safety, in that case an easier and more sustainable solution would be just to get rid of dumb regulators, those who think that what is ex ante perceived as safe is more dangerous to the banking system than what is perceived as risky. 

@PerKurowski ©