Professor Richard Thaler, do not give lousy regulatory Econs, the excuse of only having misbehaved cause they are Humans
Professor Richard Thaler opens his great and fun ”Misbehaving” with ”Virtually no economists (Econs) saw the financial crisis of 2007-08 coming” and then explains that it all has much to do with human behavior (Humans).
But hold it there Professor, plain lousy Econs should not be given the easy way out justifying it all with them only having misbehaved because they are Humans.
That a bank crisis had to explode, sooner or later, was perfectly predictable.
It used to be that each dollar in net risk adjusted margin paid by those perceived as safe and those perceived as risky was worth the same.
But with the introduction of credit-risk weighted capital requirements for banks that changed.
For instance in Basel II, the net risk adjusted margin dollars paid by those rated AAA to AA were worth 62.5 equity leverages (ELs), while the dollars paid by unrated borrowers, for instance SMEs, were only worth 12.5 ELs.
And so of course banks would sooner or later have too much assets against little capital in what was perceived as safe, and too little assets exposure against decent capital in what was perceived as risky.
And any econ, with his Optimization +Equilibrium = Economics should be able to tell you that.
The problem with the regulators in the Basel Committee for Banking Supervision, the Financial Stability Board and the IMF is that they were plain lousy Econs
Basel II data for calculating the Els:
AAA-AA rated had a 20% risk-weight which times Basel II’s basic capita requirement of 8% results in a specific 1.6 capital requirement meaning bank equity could be leveraged 62.5 times to 1.
Unrated borrowers had a 100% risk-weight which times Basel II’s basic capita requirement of 8% results in a specific 8% capital requirement, meaning bank equity can then be leveraged 12.5 times to 1.
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