The introduction to my column is this:
I RECENTLY asked a group of colleagues — and myself — to identify the single most important development to emerge from America’s financial crisis. Most of us had a common answer: The age of the bank run has returned.
I would like to see more discussion of how the permanently high demand for T-Bills as collateral will affect the U.S. economy:
Another feature of this new order is that more and more financial transactions will be collateralized with the safest securities possible: United States Treasuries. Demand for them will remain high, and low borrowing costs will ease our fiscal problems. Still, the resulting low rates of return serve as a tax on safe savings, encourage a risky quest for yield and redistribute resources to government borrowing and spending. It isn’t healthy for the private sector when investors are so obsessed with holding wealth in the form of safe governmental guarantees.
The bottom line is this:
The core problem is that the growth of short-term credit has been outracing our ability to protect it, and since 2008 most investors have realized that these shadow-banking transactions are not risk-free.
I didn’t have space to discuss whether this was a corporate governance issue or a moral hazard issue. Under one view, managers/CEOs could purchase capital insurance to plug the runs, they just don’t have the incentive to do so. The downside simply isn’t that bad for them. Under another view, the market for “runs insurance” creates too much moral hazard to be feasible, or to some extent the market exists (CDS, etc.) but it just pushes the problem back another level and may even make matters worse by creating another level of credit. A third view is that the collateral behind these short-term loans is somewhat of a farce, since it (sometimes) has value problems precisely in those world states when it needs to be called in. It is probably a bit of each.
The conclusion is this:
In short, no promising financial path is before us. It’s good that the American economy seems to be recovering, and this may shove some problems into the future. But banking and finance remain a mess at their core. Welcome to the 21st century.