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But What Would We Do For Entertainment If Banks Were Boring?

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Here is a standard set of moves in talking about bank riskiness:
1. Banks take too many bad risks!
2. Regulators should only let them take good risks!
3. All better now!

There is, like, a problem there, because actually bankers tend to have compensation structures that are more directly tied to their success, and also larger, than those of bank regulators - which means that, if you had to guess who would be better at picking the good risks, you might pick the bankers over the regulators. You can try to address that problem, maybe by improving the incentives of the regulators to make them better at picking the good risks, or by improving the incentives of the bankers to make them better at picking the good risks, because after all your goal is actually not optimal regulation but optimal risk-picking.

There are other approaches available. Here is a cop-out option:

Banks must therefore be restricted to those activities, like making traditional loans and simple hedging operations, that a regulator of average education and intelligence can monitor. If the average examiner can’t understand it, it shouldn’t be allowed.

That quote is from this baffling thing by Amar Bhidé in the Times today about how the government should guarantee all bank deposits, and then go on to "reinstating interest-rate caps, ending the competition for fickle yield-chasers that helps set off credit booms and busts," and that once that happened "Other, more mysterious denizens of the shadow banking world, from tender option bonds to asset-backed commercial paper, would also shrivel," and, okay, whatever, but I learned a whole lot about cross-elasticity that day I studied for the CFA and I'm pretty sure that when you lower the interest that banks can pay on deposits, people will be more, not less, interested in alternative higher-yielding thingies.

Felix Salmon also makes fun of this because he's not down with guaranteeing deposits but I'm not sure that's actually a big deal. Per his numbers, over half of US bank deposits are already FDIC insured, and basically any human who wants to get their bank deposits FDIC insured can do so with wholesale CD brokering and other things that I do not know much about because, sadly, I am the sort of human who fits comfortably under FDIC limits all on my lonesome. But deposits are not the thing! Other things are the thing! Worrying about the safety of the short-term liabilities of banks and nonbank financial institutions is a worthwhile activity. Worrying about the safety of actual bank "deposits" is so 1930. Here, have a chart:

The light blue is insured deposits. One of those pink bands near the top is the uninsured deposits. The rest of it is what to worry about. Bhidé just assumes that those things will go away under his plan, either because you'll be so excited about unlimited FDIC guarantees that you'll put your money in bank deposits even if they pay less interest than they do today, or because the other things will be banned I guess.

But I want to spend more time enjoying that quote, about how "Banks must therefore be restricted to those activities ... that a regulator of average education and intelligence can monitor." You can start by substituting other industries for "banks." "Surgeons," for instance, or "telephone designers." Or "particle physicists whose work might create a black hole and destroy the universe." The only industry that I know of that follows a rule of "never do anything that is not understandable to people of average education and intelligence" is politics and how is that working out for you?

There are real arguments for "dumb regulation" of banks, and there are real arguments that US regulation of depository banks has actually been pretty good at avoiding catastrophic risk-taking by insured banks and so has scored some points versus the more haphazard regulation of bank holding companies and investment banks and money market mutual funds and hedge funds and MF Globals. But there are, I think, some steps from there to "we should ban all financial innovation that you can't explain to your grandmother." We don't do that in other industries. Not even the universe-destroying ones.

We do other things. We align incentives. (If you build a particle accelerator that destroys the universe, you are sad, or at least you aren't happy, so you have ex ante incentives not to do that.) We impose after-the-fact liability. (If you are a surgeon who screws up, you get sued.) Sometimes, we get expert regulators and we do our very best to get them to be smart and motivated. We try all of these things in some form with financial regulation, and have pretty mixed success.

It is a tragic failing of financial industry PR that everyone just assumes that complexity is necessarily and intentionally evil, and that everyone will be better off with simplification. One way to test that theory is to look at revealed preferences. That chart, for instance: while old-school deposits (insured and otherwise) have grown a bit in the last 20 years, other forms of "money claims" have grown far more rapidly. You can tell that as a marketing story - banks bamboozled investors into taking asset-backed commercial paper when all they wanted were plain vanilla deposits - but you can just as easily tell it as a demand story - customers wanted yield or collateral or different risk exposures and so put their money into asset-backed commercial paper. (Or, if that's not good enough, super-fancy asset-backed stuff.) The marketing story has the disadvantage of assuming that the customers are idiots. Some of them probably are. That's probably not enough reason to dumb down the entire financial system.

Bring Back Boring Banks [NYT]


Banks Prove That They Are Not Too Big To Fail By Saying "We Can Fail" On A Piece Of Paper, Moving On

One way you could spend this slow week is reading the "living wills" submitted by a bunch of banks telling regulators how to wind them up if they go under. Don't, though: they're about the most boring and least informative things imaginable and I am angry that I read them.* Here for instance is how JPMorgan would wind itself up if left to its own devices**: (1) It would just file for bankruptcy and stiff its non-deposit creditors (at the holding company and then, if necessary, at the bank). (2) If after stiffing its non-deposit creditors it didn't have enough money to pay its depositors it would sell its highly attractive businesses in a competitive sale to willing buyers who would pay top dollar. This seems wrong, no? And not just in the sense of "in my opinion that would be sort of difficult, what with people freaking out about JPMorgan going bankrupt and its highly attractive businesses having landing it in, um, bankruptcy." It's wrong in the sense that it's the opposite of having a plan for dealing with banks being "too big to fail": it's premised on an assumption that the bank is not too big to fail. If JPMorgan runs into trouble that it can't get out of without taxpayer support, it'll just file for bankruptcy like anybody else. Depositors will be repaid (if they're under FDIC limits); non-depositor creditors will be screwed just like they would be on a failure of Second Community Bank of Kenosha.