Friday, November 4, 2016

To the moral hazard of government guarantees, you should add any regulatory distortion hazard.

Because of current risk weighted capital requirements for banks, banks are allowed to leverage any government guarantees more with assets ex ante perceived, decreed or concocted as safe, than with assets ex ante perceived as risky.

So when government guarantees are awarded when this regulation is imposed on banks, something which clearly distorts the allocation of bank credit to the real economy, then you have to increase the moral hazard with the regulatory distortion hazard.