Sunday, October 20, 2013

Worse than the high speed allowed trucks, is just that different speeds are allowed.

Anat Admati in “The Compelling Case for Stronger and More Effective Leverage Regulation in Banking” October 14, 2013, refers to “The speeding analogy” which appeared in hers and Martin Hellwig’s splendid book "The Bankers' new clothes"

“Imagine that trucks were allowed to drive faster than all other cars on the road even though they are the most dangerous. Further suppose that the trucking companies and the drivers are rewarded the faster they are able to make a delivery, benefit from subsidized insurance, and have a special safety system that protects the driver in case of accidents and explosions. The companies might produce narratives suggesting that their deliveries are essential and that the fast delivery is important for economic growth. They and others might produce models suggesting possible “tradeoffs” associated with a lower speed limit for the trucks. Whereas there probably are tradeoffs associated with trucks driving too slowly, it is clear that they are irrelevant, and there are no tradeoffs, when choosing between 90 miles per hour and 50 miles per hour for a truck carrying dangerous cargo in a residential neighborhood”

Admati is absolutely right, but, the danger of heavy trucks speeding too fast through our neighborhoods is only part of the conclusions that should be drawn from that analogy. More than the allowed speeds I have for many years argued that just allowing different vehicles, based on safety ratings, to be allowed to drive at different speeds (risk-weights) on the same streets, guarantees mayhem. Sooner or later those safety ratings, will either be captured by interested speeders, or simply be wrong; and besides these loony traffic regulations will make it more difficult for doctors, fire trucks and other vital essentials to arrive in time.

And that is of course why I give much more importance to eliminating the risk-weighting of the capital requirements for banks, than just increasing the basic capital required. In fact the more capital banks are asked to put up means that, while that is being taken cared off, the worse will be the effective discrimination against those who, even though they in fact pose no major risks for banks, have been castigated with the highest risk weights.