But Where Is the Doctor?

Based on Edward Kupiec’s Wall Street Journal op-ed I can’t quite make out whether he opposes bank regulation because it’s ineffective:

Macroprudential regulation, macro-pru for short, is the newest regulatory fad. It refers to policies that raise and lower regulatory requirements for financial institutions in an attempt to control their lending to prevent financial bubbles.

These policies will not succeed. Consider the most common macroprudential tool: raising or lowering bank minimum capital standards. Academic research—including a recent study I co-authored with Yan Lee of the Federal Deposit Insurance Corp. and Claire Rosenfeld of the College of William and Mary—has found that increasing a bank’s minimum capital requirements by 1% will decrease bank lending growth by about six one-hundredths of a percent.

or because it’s effective. It may be a more general distaste for regulation:

Government regulators are no better than private investors at predicting which individual investments are justified and which are folly. The cost of macroprudential regulation in the name of financial stability is almost certainly even slower economic growth than the anemic recovery has so far yielded.

In my view the only possible sense that the “save the banks and bankers first” strategy we have used made was as an emergency measure. Whatever emergency there was passed long ago. I can only guess that some combination of self-interest and the baleful effect of mathematics on economics has not only prolonged emergency measures but turned them into an investment strategy.

The reality is that while the economy will be weaker without sound banks, banks cannot becvome sound without a solid underlying economy and regulators, legislators, politicians, and pundits have fought any measure that might have put the economy on a sounder footing with all of their might.

7 comments… add one
  • TastyBits Link

    There is not enough industry knowledge built up in the regulatory agencies, and the new regulators must rely upon the industry itself for that knowledge. This is where the regulatory capture begins. In an industry where there are senior regulators with a large number of combined years experience, the environment is vastly different. It is similar if a large number of the senior regulators retire or quit.

    Because of this gap, it is almost impossible for the government to stay ahead of the latest scheme in any industry. Also, the regulators will sympathize with the industry. If the industry goes under, the regulators go with them.

    In a fractional reserve lending system, most of the banks balance sheet is created money, and raising the capital requirements does have an effect on how much money they can create. Prior to the 2008 financial crisis, it probably would not had an effect because everybody thought they could create money at will.

    The banks cannot become sound until they become solvent, and they cannot become solvent until the bad debt is written off, written down, or worked off. There is probably only another ten to twenty years to go, but at least, those damn borrowers are going to pay.

  • Guarneri Link

    There is a lot more going on in those two excerpts than people might imagine. It’s not either/ or.

    I’ve thrown around the notion of the current financial bubble ( and I still think I’m correct) but wondered when someone would actually ask the right question: “how do you know that risk premiums have become so irrationally low that valuations have become irrationally high? You have no rational theory of irrationality.” The same can be asked of bank lending. The ebbs and flows of lending standards are similarly prone to boom and bust (high default rates ). The only solution to lower the risk of bank runs and failures during periods of post exuberance high default rates is greater capital adequacy. “Unwarranted” capital requirements would lead to lower growth. The only way to find the Goldilocks capital standard is perfect knowledge, and banks run by Mr Spock. I have no idea how the author controlled in his study for moving risk premiums, but he’s claiming banks are run by anti-Mr Spocks. Call me dubious.

    As for his second point, he is simply pointing out that there is no reason to believe that government would do better than markets. I would strongly argue that government would do worse. An inconvenient truth in the housing bubble is that the single largest buyers of subprime mortgages were Fannie and Freddie. The author worries that slow growth would be the result of government credit decision making. I differ. I would suggest that since loan recipients vote, the government would be absolute wizards at making loans………collecting them, not so much. Similarly, since deadbeat creditors also vote, I’m thinking loan collection activities might not be so robust. Disagree? Check out an Obama speech on student loans.

    So what is the answer? I have no magic bullet. But my thinking on this hasn’t changed in a decade. It’s what I call the standard model: bank gets in trouble?? Start washing out the capital structure from the bottom up and let fresh money take the go forward risk and spoils.

  • Guarneri Link
  • ... Link

    I liked the story in the LA Times stating that 1 in 5 of US workers had been laid off in the last five years. Not clear when the survey was conducted but it sounds recent. Which means 20% of workers have been laid off during the recovery. No data on how that compares to other recoveries but that sounds high.

    It also included all the usual data about how hard it is to find jobs, how the jobs newly found pay less, how a large number of people can’t find jobs at all, how long term unemployment negatively effects standard of living, yadda yadda yadda.

    But the neat part was at the bottom of the page, where the LA Times ran a series on ridiculously expensive homes for sale in the LA area.

    Peons and padrones in the City of Angels.

  • ... Link

    And Drew has missed a chance to insert a Van Halen link.

  • Guarneri Link

    Off my game. Tormenting Michael at OTB. Some things never change, though. Jeff Foxworthy would be proud. “Are you a racist, homophobic, drooling idiot? You must be a Republican. “

  • Lazy-assed VCs can’t even insert their own links these days. LImp-wristed lot they are.

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