In the NYTimes, an argument for tighter bank regulation
Governments should fully guarantee all bank deposits — and impose much tighter restrictions on risk-taking by banks. Banks should be forced to shed activities like derivatives trading that regulators cannot easily examine.
Right now in the U.S. FDIC insurance only covers $250,000. The author argues that if all deposits were 100% guarenteed, there would be fewer bank runs and financial crises would not be so bad. To mitigate risky lending, the government should act as a tight regulator, and ban trading in financial instruments like derivatives.
AM: Unfortunately, the author does not address some of the counterarguments. Fully insured deposits would create a major moral hazard problem as the rich depositers would not care at all what banks did with their money. This problem already exists to some degree, I would imagine, with insured deposits. The author would likely counter that "this is the point of regulation." I would respond: "you have a lot of faith in regulators."
There is no resolving this one, but the contours are familar: which way should we choose, more bottom up or more top down? I have more faith in bottom up. Banks don't 'self regulate' but they do act in their own self-interest and respond to incentives. Risk taking has been fed by a culture of bail outs, which created a massive moral hazard problem. FDIC insurance (and bail outs in general) perverts incentives, and so you need top down oversight, sure. But that creates its own problems: regulators don't have perfect information; they are subject to capture by private and political interests; they create new burdens of compliance and new inefficiencies.
CDIC and FDIC are for the protection of consumers, not banks. They insure us in case the bank goes belly up. If they do the gov will replace your savings upto 250k - the bank doesn't get anything, unless they get bailed out by the Gov.
ReplyDeleteI think this type of protection is benificial to consumers because without it your money might be safer under a bed somewhere. This type of protection gives consumers confidence to deposit their money with a bank, who can then turn around and use it for investment etc.
CM
banks won't take risks if they think you'll pull your money out and sign up with a "less risky" competitor. Or if they do take risks
ReplyDeletethey'll have to pay higher rates on their deposits. Right now, you don't care. I don't care. The banks do what they want with the cash within the bounds of the law. If they lose it, we're covered. If we
were not, do you think you'd have the same attitude?
So, banks ar emore risky because their key lenders are not vigilent. This is the exact same problem as moral hazard and bail outs. Investment firms can be highly leverged but their creditors don't care if they think they're covered.
Wow, I hadn't thought of that similarity between bail outs and insurance. Smart post, AM.
ReplyDeleteGerman
As usual free market fundamentalism leads to absurd conclusions: end deposit insurance? are you crazy! that protects people from the greed of the big banks, which, i fyou haven't noticed, are not exactly careful with their money. The NY times guy has it right on 100 percent; full insurance + tihgt control will get the best results.
ReplyDeleteHM
FDIC and CDIC doesn't protect anyone from what the big banks do, it simply shifts the onus or burden to taxpayers if a bank goes belly up. I agree with AM's point, but as a whole, I can see how these insurances will make one sleep a little easier at night. The bigger question is, could the CDIC, or even worse the CMHC, comeback to bite us one day in the event of a major financial meltdown? Where is the moral hazard here? One thing seems certain, misery loves company. And as long as the few don't get left high and dry, most are ok with that.
ReplyDeleteThe CMHC, eh? Good question . Housing prices are pretty high in Canada, though?.
ReplyDelete