Eric Falkenstein on leverage regulation

What about leverage as a proxy for this unmeasurable risk? As Proshares is showing with the Ultra (2x leverage), UltraPro (3x leverage), and short products, a security can have double or triple leverage behind it, have positive or negative exposure, and still called a 'stock'. Similarly, a bank with 10:1 ratio but plenty of ninja loans had a lot more risk than a bank with 20:1 leverage but all their mortgages had 20% down (the bad old days per Alicia Munnell). Facility risk (eg, loan-to-value) is part of the problem, so too is obligor risk (eg, credit and bureau scores), and so the multiheaded beast grows, with risk hiding from any one metric that can be applied across any large financial institution.

There is more at the link.  I agree with him too.  Overall, I am not very optimistic about our ability to regulate the financial sector successfully.  Leverage regulation is simply the best idea of a bad lot, of what I've seen.  It addresses one problem, but only one problem.  There is the related question of how off-balance sheet risk rises, to compensate for the restrictions on the balance sheet.  Still, the bottom line question is whether you wish for a LLR without any leverage restriction and I believe the answer is no.

Addendum: Arnold Kling comments.


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