…there are few crises I have known from the inside that would not have happened if only there was more disclosure. People knew that sub-prime was a poor risk – it is called sub-prime, after all.
Then it moves here:
The alternative model rests on three pillars. The first recognises that the biggest source of market and systemic failure is the economic cycle and so regulation cannot be blind and deaf to the cycle – it must put it close to the centre. Charles Goodhart and I have proposed contra-cyclical charges – capital charges that rise as the market price of risk falls as measured by financial market prices – and a good starting point for implementation of such charges is the Spanish system of dynamic provisioning (Goodhart and Persaud 2008).
The second pillar focuses regulation on systemically important distinctions, such as maturity mismatches and leverage, and not on out-dated distinctions between banks and non-banks. Institutions without leverage or mismatch should be lightly regulated – if at all – and in particular would not be required to adhere to short term rules such as mark-to-market accounting or market-price risk sensitivity that contribute to market dislocation. Bankers will argue against this, saying that it creates an unlevel playing field, but financial markets are based on diversity, not homogeneity. Incentivising long-term investors to behave long-term will mean that there will be more buyers when banks are forced to sell.
The third pillar is requiring banks to pay an insurance premium to tax payers against the risk that the tax payer will be required to bail them out. If such a market could be created, it would not only incentivise good banking and push the focus of regulation away from process to outcomes, but it would provide an incentive for banks to be less systemic. Today, banks have an incentive to be more systemic as a bail out is then guaranteed. The right response to Citibank’s routine failure to anticipate its credit risks is not for it to keep on getting bigger so that it can remain too big to fail, but for it to whither away under rising insurance premiums paid to tax payers.
An insurance premium on excessive risk?
The constitution has a better method, slavery of the income tax. Increase progressive income taxes on the wealthy when the risk of failure increases. The effect will be that the super wealthy get government right. They will reduce their insurance premium by reducing the risk of government boondogle.
“to whither away under rising insurance premiums”
Whither ‘wither’?
So the solution to food shortages is to stop government policies that favor romantic small farms over efficient larger producers? And the solution to credit shortages is to create new government policies that favor romantic small lenders over efficient larger producers?
Well the smaller banks wind up selling the loans to the larger banks after taking a portion from the profits, so I don’t see how that is more effective… unless the smaller bank can operate a profit margin less than the expenses the larger bank can operate had they just wrote the loan themselves to begin with. Plus, every hand hat touches the loan from the customer, to a broker to a pass through lender to the final bank… with each touch there lies the possibility, or in the case of sub-prime the probability that there will be undetected fraud in the loan somewhere. I am not so convinced closing loans more quickly ought to be the benchmark in the future. Maybe insuring that they are well underwritten should instead be. When things come back, as we all know they will… maybe we won’t see 100% financing of a home to somebody who couldn’t otherwise qualify for a revolving credit card.
“The third pillar is requiring banks to pay an insurance premium to tax payers against the risk that the tax payer will be required to bail them out. ”
What ever happened to PMI? Shouldn’t this insurance be covering much of the problems in the mortgage crisis?
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it is an interest story
really interesting
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