Sunday, April 4, 2010

My response to 'Reintroducing Another Libertarian Case For Severe Financial Regulation'

Basically, I thought they were being too shortsighted, and failing to see the real reasons why the market is failing to regulate itself.

Their solution is basically leverage caps. My response comes after the quote.

Business Insider:

Leverage (rather than size) caps may be the answer.

As Felix Salmon recently pointed out in response to a Tim Geithner letter opposing hard leverage caps (on the grounds that foreign banks might have larger caps, rendering ours unable to compete), the last thing we want is to return to a banking system where everyone just competes on leverage alone.

Leverage caps. Holy shit. Is that our level of thinking here? No kidding there should leverage caps. There should be no fractional reserve banking either. That entire thing is leverage. 100:1 leverage once you allow for customers redepositing bank credit that is then used to write more bank credit.

The real solution to this is to not allow bank credit to be the same thing as US dollars. That makes it seem as if the credit worthiness is the same for all banks. It's not. Banks have different credit worthiness, but because they can issue their credit as US dollars we never see the impact of their credit worthiness on their notes.

This isn't how it always was. Banks would essentially write IOU's to their customers back in the 1800's, and people had the right to accept or reject those IOU's. Now, people may say there were problems back in the old days, but I think that's more because there was no branch banking allowed, and because banks were forced to buy potentially worthless state and later federal bonds for their holdings.

Another way to ensure regulation is by having a company or companies like the FDIC that actually do its job. The FDIC provides insurance on accounts up to a certain level in case a bank crashes. Well, the premium charged should vary from bank to bank based on the credit worthiness of the bank. As far as I know, not only does this not happen, but banks didn't pay ANY premiums to the FDIC for 10 years. They simply received the service from the government for free. The tragedy of this is that not only does it unfairly put the tax payer at risk, but it also removes another opportunity for market regulation. How can we expect the market to regulate itself if we take away all its opportunities to do so?

Lastly, there's the ratings cartel. Those guys Moody's, S&P's, Fitch, they all have a legal monopoly on ratings. If pension funds, etc., want to buy some financial instrument, it has to be given a minimum rating by one of those three agencies. Well, we see how well that worked out. Again, we take away a free market, and replace it with a government controlled one.

So, should there be things like Glass-Steagall and leverage caps? Sure, I don't see why not (in fact even Rothbard was for Glass-Steagall back in the day), but the only reason we need these things is because we take away the market's ability to regulate the credit worthiness of these institutions by making all bank notes equal, and making all insurance premiums for possible defaults the same.

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