Decreed Inequality
John Kenneth Galbraith wrote: “The function of credit in a simple society is, in fact, remarkably egalitarian. It allows the man with energy and no money to participate in the economy more or less on a par with the man who has capital of his own. And the more casual the conditions under which credit is granted and hence the more impecunious those accommodated, the more egalitarian credit is… Bad banks, unlike good, loaned to the poor risk, which is another name for the poor man.” “Money: Whence it came where it went” 1975.
And that pro-egalitarian function had to face that natural risk aversion of bankers supposedly described by Mark Twain with “A banker is a fellow who wants to lend you the umbrella when the sun shines and wants it back when it rains”.
But since “poor risks” could always offer to pay higher risk premiums than the “safe”, and a dollar paid in interest was a dollar whoever paid it, the “poor risks” of yesterday, frequently got the opportunities for bank credit that in many cases transformed these into the safe of today.
No longer. Bank regulators, wanting nothing but safer banks, decided since the early 1990s that the natural risk aversion of bankers was insufficient, and decreed risk weighted capital requirements for banks.
With it banks are required to hold more capital (equity) against assets perceived as risky than against those perceived as safe; which meant banks are able to leverage equity less with loans to those perceived as risky than with loans to those perceived as safe; which meant banks earn lower expected risk adjusted returns on equity lending to the risky than lending to the safe; which means that dollars paid in net risk adjusted margins on loans by the risky do not any longer have the same value than the same dollars paid by the safe; which means that no longer have the “risky poor” fair access to bank credit, while that of the “safe rich” is de facto subsidized.
And this is what I mean with “Decreed Inequality”. How many millions of SMEs and entrepreneurs have not been given the opportunity to advance with credits over the last 25 years as a direct result of it? That would never have resulted in a free market with unregulated banks. And it sadly also means that banks no longer finance the “riskier future” but only refinance the “safer past”.
And in terms of “safer banks” it was and is all for nothing, as major bank crises never ever result from excessive exposures to something perceived ex ante as risky. The 2007/2008-bank crisis would never have happened or, if so, remotely had been of the same scale had banks not been regulated. A free market would never have knowingly allowed banks to leverage 30 to 50 times their equity like regulators did.
Do I think banks should not be regulated? Absolutely not! I am only reminding everyone of the fact that the damage dumb bank regulators can cause with their meddling, by far surpasses anything the free market can do.
And please, please, please, stop talking about "deregulation" in the presence of such an awful and intrusive mis-regulation.The regulators imposed the worst kind of capital controls.
Question: SCOTUS, does such discrimination in the access to bank credit reflect the spirit of the US Constitution?
PS. Through the bathroom window of the Basel Committee for Banking Supervision, and by decreeing the risk weight of the sovereign to be zero percent, while that of the private sector was set at 100 percent, the regulators also smuggled in horrendous statism.
P.S. Here is a link to a more detailed aide memoire on the horrible mistakes of risk-weighing the capital requirements
PS. Then on top of it all, they top it up with QEs fiscal deficits and other stimulus, that primarily benefit those who already own assets (shares/houses)
PS. Here is a letter on this issue the Washington Post published
And here is my 2019 letter to the Financial Stability Board
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