Thursday, August 14, 2014

No more champagne, only milk, and which sooner or later could turn sour or even dangerously spoiled

Perceived credit risks are similar to those risks described by Hans Karl Emil von Mangoldt in his 1855 example about the risks that a bottle of champagne bursts, and referred to by Frank H. Knight in his 1921 “Risk, uncertainty and profit”. 

In essence it all boils down to that those risks do not alter the results, the profits, because they can be accounted and provisioned for.

And yet, our too creative and I would say too loony bank regulators decided that if a bank was going to produce champagne using “risky” bottles, it needed to hold much more capital (equity), than if it was going to produce milk using safer milk bottles.

No wonder we now find less and less of the exciting champagne in our economies.

But “we have at least milk” you say? Not so, there are risks with binging on milk too.

Our bank crises have never ever resulted from banks drinking too much risky champagne, these have always resulted from drinking too much of what ex ante was considered as very safe milk, but that ex post turned out to be quite soured milk... or even dangerously spoiled milk.