Thursday, October 7, 2010

What Are Banks For?

Noah Millman begins a great post with that question.

Best line:
What’s the residual risk on a AAA security hedged with a AAA counterparty? Enough to bankrupt Goldman Sachs, apparently.

His conclusion on how to fix the financial system is basically what I've been saying here for months now -- Forget the other stuff, focus on leverage. Increase capital and collateral requirements sufficiently and the rest will take care of itself. The question,at least for FLG, is what's sufficient?


Anonymous said...

This is a yesbut response. Yes, all that is important. And, you gotta find a way to align the individual incentives with those of the institution. If you can be a star for several years taking huge risks with the institution's treasure, and get bonuses, and get the hell out, it really doesn't matter too much what the consequences for the institution are, Nick Leeson or Jerome Kerviel is going to do what he is going to do. dave.s.

FLG said...

Increasing captial and collateral will do that indirectly. If you need to come up with a bunch of cash to take a risk, then banks will pay more attention to the risk being taken. In all likelihood, this means align the incentives.

Nick Leeson and Jerome Kerviel are different. That's out and out fraud. The best you can do there is try to force collusion, but it's not really a systematic financial regulation issue.

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