Monday, August 29, 2011

Charles Goodhart on Banking Reform

The calls for better bank regulation are many. This column argues that regulators have the concepts right, but the mechanisms are in need of repair.

Goodhart's chief point is that to accomplish its purpose, bank regulation needs to be designed in a way that gives regulators an early enough indicator for timely intervention, before the situation has deteriorated to the point at which a fiduciary institution with characteristics of a public utility is insolvent or nearly so.

15 comments:

Clonal said...

The problem with the banks is that they are sitting on bad loans that they cannot afford to write off. Losses are charged against bank capital. Increasing the bank reserves does nothing to enable the write off, or to reduce the losses.

Hence the constant refrain "Banks will need to raise more capital."

But from where is that capital going to come? From private investors? Not a chance! Who in their right mind will put in money when they know that the money will be used to write off bad loans? Also the magnitude of the losses is so great, that it is unlikely that private investors will be able to come up with the necessary sum.

That leaves only one possible source of capital! But that one is a bitter pill to swallow, and leads to much cognitive dissonance! So, we stumble along unable to resolve the crisis!

GLH said...

I know that there will no regualtion of the banks until the end game comes. I can't believe this is over.
Mr. Hickey, I never like to intrude in anything and then switch the subject to what I want to discuss. But, I have some questions for you.
I've been dicussing economics with a friend and trying to disabuse him of the idea that the Fed should be eliminated. I explained that the Fed doesn't loan money and only changes reserves in the banking system. But, he has found from some source that the Fed has loaned 20T or more to offshore banks and mega-corporations.
First, am I not correct about the reserves?
Second, do you know how the Fed loaned the money and why?
It seems I remember it being discussed around 08, but I don't recall much about it.

Matt Franko said...

Clonal,
at least it seems Lagarde sees this:
http://online.wsj.com/article/SB10001424053111904332804576538223495135738.html?mod=googlenews_wsj

Problem with her plan is no one goes to jail, no reforms to prevent it from happening again, nothing to address the AD weakness... etc

Resp,

Matt Franko said...

GLH,

Fed is "lender of last resort" so in crisis situations they are supposed to lend. Problem is not the Fed structure imo, it is the morons that are running it. These same morons should never have let Lehman go down via bankruptcy, thus creating their own problems that they then had to deal with...

They did not lend the system 20T at one time, those who phrase it that way are using rhetoric and it is deceptive language.

They made a long series of short term loans that they turned over weekly/monthly/quarterly that I suppose if you added all of the transactions up, might hit 20T. But if you make a series of 1 week loans for 1M a week for 50 weeks, you wouldnt say you loaned "50M"....

Resp,

TomatoBasil said...

Italian Town Mints Own Money to Fight Austerity

GLH said...

Matt Franko:
I read that piece at Warren Mosler's, but there wasn't enough for me to understand how the Fed is supporting the other banks. Is what the Fed is doing similar to what the ECB is doing within the Eurozone? Is it legal for our Fed to do what it seems to be doing? Forget the last question. Can you give me an article or something that might help me understand it?

Matt Franko said...

GLH,

Which 'other' banks? The foreign banks?

GLH said...

Matt Francko:
From what I was told the Feb has given $20T to overseas banks and mega-corporations. I don't know if it is the case or, if it is, what is being done with the money. I'm looking for enough information with which to discuss the situation. I appreciate any help I can get.

Clonal said...

Matt,

The moral hazard and the frauds have to be dealt with. Not only for the past transgressions, but also regulating heavily for the future. My preference is to nationalize banks, make the Fed a part of treasury - do away with the stupid restrictions on the Treasury issuing money AND to go to FULL RESERVE banking as suggested by AMI and the Kucinich bill

Tom Hickey said...

GLH,

The Fed is the government's bank. Congress has decided that it should be an agency formally separate from Treasury. The purpose of the Fed is to establish monetary policy, regulate the financial sector, and operate the interbank settlement system. Reserves are the money thing through which interbank settlement takes place. Only the Fed can create reserves and it uses monetary operations to regulate the quantity of reserves so that it can set the price (interest rate).

The Fed is also the lender of last resort to the banking system. The banking system is now international and interdependent, so the Fed acts as lender of last resort to the world in extremis since the dollar is the global reserve currency. Failure to do so risks global financial crisis due to lack of liquidity, i.e., everything freezes up as banks cease to lend to each other.

Ask your friend if he has thought through the present system and how it operates, and how the US and world economy would operate without a central bank of the US. It is simple to say, "End the Fed." It's more difficult to come up with a comprehensive alternative.

Not the the present system cannot be changed. MMT economists have proposed changes. Others have as well. The AMI-Kucinich Treasury system is one such proposal that is being put before Congress.

Ralph Musgrave said...

Can anyone think of a good reason why banks should have “lender of last resort” facilities available to them, while denying the same facility to cab drivers, plumbers or massage parlours?

GLH said...

Mr. Hickey:
I understand that you are saying that the Fed is not loaning money, but being central banker to the world. That would mean that some commentators are confusing the issue.
I appreciate your input and I will relay that information. The problem is that some people never realize the function of the Fed, but I will continue with trying to explain how the Fed operates to my friend.
Just last night I had the oportunity to Listen to Ron Paul who said he wanted to end the Fed and return to the gold standard. I can't blame regular people for being confused when the politicians propose such ideas.
Thank you.

Clonal said...

GLH

The problem with the gold standard in the US can be seen very clearly in the graph in Ralph Musgrave's article - Economic fluctuations since 1870. Remember that the US went off the gold standard domestically in 1935, and Nixon shut the gold window on Aug 15 1971.

postmodernprimate said...

The Fed makes a mockery of Bagehot's "Lender of Last Resort" rule.

“Lend freely, against good collateral, at penalty rates”

The Fed lends freely, against junk collateral, at risk-free rates. Providing liquidity in a crisis has been an accepted principle since Bagehot but he made a strict distinction between solvent and insolvent institutions and viewed supporting the latter as subsidizing moral hazard.

Tom Hickey said...

The Fed lends freely, against junk collateral, at risk-free rates. Providing liquidity in a crisis has been an accepted principle since Bagehot but he made a strict distinction between solvent and insolvent institutions and viewed supporting the latter as subsidizing moral hazard.

Yup.

Moral hazard = perverse incentives