Tuesday, June 26, 2012

On bankers and weathermen

Do you remember Mark Twain’s banker, he who wants to lend you the umbrella when the sun shines but wants to take it back as soon as it seems like it is going to rain? Well that banker would surely be taking some notice of what the weathermen opined, in order to set the interest rates, the amounts and the other terms of the loan. 

But what if the regulators also told this banker that if the weatherman spoke of sun, his bank was allowed to hold very little capital, which meant being able to leverage its equity much more, but, if he spoke of rain, it was then required to hold much more capital and leverage less? 

Obviously, since a banker must love returns on bank equity, since otherwise he would be booted, that would doom Twain’s banker to choke on sunny forecasts (like AAAs and infallible sovereigns), and avoid like the pest all possible rains (like small business and entrepreneurs)… only to find out, much too late, that weather reports are not always that accurate. 

And so shall we exclude using weather forecast from bank capital requirement calculations, or shall we regulate the weatherman… so that he gives our bankers absolutely accurate forecasts… so that our Mark Twain banker can trust these even more?