Mark Thoma has good links and good discussion. I don't know the "inside scoop" on the bank books, but in purely theoretical terms a bit of chicanery may be socially optimal now. In general, bank moral hazard-induced-risk-taking may move closer to socially optimal, the closer banks are to insolvency. Let's say that banks are generating high profits now by, one way or the other, pursuing short run profits and "going short" on market volatility. In the long run this investment strategy will bite them, sooner or later but probably later. In the meantime they likely will become solvent. If insolvency has a high fixed cost this can be a good risk, even from the taxpayer or social point of view.
Of course one does not want for this game to continue forever and it is hard to stop once it gets rolling. But on a period-by-period basis, now is not the ideal time to stop. Now may be the time to allow such opportunistic behavior to get banks out of the range of possible insolvency. Tolerance is a kind of invisible subsidy that costs us something only stochastically or in the more distant future.
How much of the bank profits, and resulting exec. compensation, reflect not just short run profits, but pure rent-redistribution? By definition, redistributing billions in rents to the bank execs makes the rest of us poorer. That’s not too appealing from the taxpayer or social point of view. Maybe we should take this opportunity to try to design institutions, including our tax and regulatory structure, with better incentives on that front.
there’s not that much chicanery required for high banking profits.
because ‘everyone’ wants short term instruments and liquidity, the normal business of banks (alternatively known as ‘maturity transformation’, ‘providing liquidity’, or ‘funding long term loans with short term instruments’) is quite profitable right now.
Describing the political thuggery of forcing the prudent to subsidize the imprudent as “tolerance” is a clear sign of an addict beyond redemption. Tyler – its time you submitted yourself to a ten-step program. Maybe one for the stochastically-impaired or how about moral-hazard-aholics anonymous.
It is always a good time to stop behavior based on looting.
Since banks borrow with a short time horizon and lend with a long one, it is truly critical that the incentives be aligned for the long term. Tolerance of anything else by the taxpayer is financial suicide.
“While the bank must indeed commit and hold capital … that period is quite short (sometimes mere seconds).”
Indeed, reported times go to the sub-millisecond range, giving lie to the notion of “holding capital† to provide liquidity.
But while I am very concerned that we capital markets participants are subsidizing the banks, let’s be clear: ever since the creation of the Fed, banks have assumed the role of handmaidens to our monetary policy types. Their profit margins are dictated by cost of funds (managed, if not controlled by the Fed Funds rate) and the market rates at which they can lend. When the Fed wants to expand money in circulation, they lower costs to make it more profitable, ceteris paribus, to lend. And vice versa.
The recent orgy of bailouts and subsidies are merely the result of spectacularly misbegotten policy over the last decade, under which the Fed made money so easy to get that the banks forgot that they were supposed to be rationing credit to the more creditworthy borrowers (which the Fed does not do in its historical role). Instead, under our “we’re practically giving it away!!!” policy, banks were convinced that they maximized profits by maximizing volume, and they only belatedly found that only the Fed gets to give it away without worrying about individuals’ creditworthiness.
We still have this deal, right? The Fed takes care of the banks, because it needs banks to carry out credit allocation while it sets the overall borrowing level. Nobody wants to pay for it, but a deal’s a deal. Except that Stiglitz keeps reminding us that there are other clauses that we could be invoking for the banks’ failures; those clauses are independent of any misfeasance by the Fed.
Your post is hogwash. The profits are going to bonus pools, not to massively reduce leverage and shore up capital.
“In general, bank moral hazard-induced-risk-taking may move closer to socially optimal, the closer banks are to insolvency. Let’s say that banks are generating high profits now by, one way or the other, pursuing short run profits and “going short” on market volatility. In the long run this investment strategy will bite them, sooner or later but probably later. In the meantime they likely will become solvent.”
Sorry, Prof. Cowen. But this is just proof that economists who haven’t bothered to study the things they’re talking about should learn to say “Hey, I really don’t know.” rather than spouting nonsense.
You are advocating the same solution that was put into place to recapitalize banks after the Latin American debt crisis and the same solution that was put into place to recapitalize banks a decade later after the fallout from the S&L crisis. Those who know their banking history realize that we are currently experiencing the long-run effects of pursuing a consistent policy for the financial system of gambling for resurrection.
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