Completely ignoring business cycle theory, money pumping, free market theory and a Federal Reserve System that protects high leverage banks and creates moral hazard, Tyler Cowen (and Kevin Drum) have spotted "market failure", stuck their fingers in the air and determined that bank leverage should be limited to 10:1 or maybe 15:1.
Bottom line: If there really was a free market in banking, you wouldn't need arbitrary government mandated leverage limits. No one in such a free market world would put their money in a highly leveraged bank, unless the interest paid reflected the additional risk. In a real free market, there would likely be all kinds of banks, just like there are now all kinds of mutual funds, from low risk money market funds to high risk double market short funds. All of these funds developed, remarkably, without any meddling from Cowen.
Wenzel,
ReplyDeleteFurthermore, in a free market, people earning interest on their money at banks would likely clearly understand they were engaged in a speculative loan-making enterprise and that there money was not available as a 100% demand deposit. Again, this would negate the "need" for any centrally mandated leverage ratios.
Unlike our current system, higher leverage would mean higher costs, either in interest payments, deposit insurance premiums (assuming such insurance would be available in a free market) or both. The reality is that free markets produce negative feedback loops that regulate more effectively than arbitrarily-controlled markets.
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