Thursday, February 25, 2016

Bank regulators cause price of credit for the safe to be lower than usual than that of the risky. It costs us a lot!

Lawrence H. Summers writes about “the concept of secular stagnation, first put forward by the economist Alvin Hansen in the 1930s. The economies of the industrial world, in this view, suffer from an imbalance resulting from an increasing propensity to save and a decreasing propensity to invest. [And that] it is natural to suppose that interest rates – the price of money- adjust to balance the supply of savings and the demand for investment in an economy” “The Age of Secular Stagnation” Foreign Affairs March/April 2016.

But the intermediation between savings and investment, when carried out by banks, has now been distorted by the fact that banks are allowed to earn higher risk adjusted returns on equity when holding “safe” assets, than when holding “risky” assets? That is the de facto result of the risk weighted capital requirement for banks.

And so now the difference in the price of bank money for the safe, and the price of money for the risky, will be much larger than what would be the case without these regulations. And, consequentially, the demand for investment of the safe will be larger than that in an undistorted equilibrium, and the demand for investment of the risky, much lower.

One way to explain it is with houses and jobs. As is, the financing of houses has been considered much safer by regulators than the financing of job creation through “risky” SMEs and entrepreneurs. And so society is, faster than little by little, getting stuck with too many houses and too few jobs.

@PerKurowski ©