The Gold Standard  

Economist has launched a round-table (second?) around a  guest ‘Economic Focus’ column by Raghuram Rajan. I just read his column but not the reactions from others, yet. The issue is about a regulatory system that is less intrusive in booms and protective (of the system) in busts. Raghu makes two suggestions. One is to have banks develop/build up contingent capital and the second is to force ‘too big to fail’ institutions to develop plans that would make them easier to close, say, over a weekend. It is contingency planning while the first one is to have capital available on call, when needed. I like the second one. It will force the banks to think about their asset size and the risks they carry on their books, if they cannot be closed smoothly over a weekend.

If you turn to Table 4 (hat tip James Aitken) of the report of the Office of the Comptroller of the Currency for the fourth quarter of 2008, you will know why this makes a lot of sense. Here is the link. 

Why am I less enthusiastic about the first one is that there are two conditions under which banks would be triggered to raise contingent capital:

First, the system is in crisis, either based on an assessment by regulators or based on objective indicators; and second, the bank’s capital ratio falls below a certain value*. 

I am not sure regulators are yet staffed or intellectually prepared to make such hard-knuckle risk assessments. It depends on a degree of autonomy and independence from financial institutions that seem to be lacking yet. Second, it also depends on an intellectual climate that is ever mindful of risk. After all, in this cycle, regulators and policymakers were cheerleading financial innovation and pronounced risks to be contained and localised. I feel that they believed (and still do?) they had achieved the ‘Great Moderation’ in business cycles. 

On the first concern I have, Willem Buiter has gone where no other commentator has dared to go, so far (hat tip Naked Capitalism):

Governments everywhere are doing the best they can to delay or prevent the lifting of the veil of uncertainty and disinformation that most banks have cast over their battered balance sheets. The  banking establishment and the financial establishment representing the beneficial owners of the institutions exposed to the banks as unsecured creditors – pension funds, insurance companies, other banks, foreign investors including sovereign wealth funds – have captured the key governments, their central banks, their regulators, supervisors and accounting standard setters to a degree never seen before.

I used to believe this state capture took the form of cognitive capture, rather than financial capture.  I still believe this to be the case for many, perhaps even most of the policy makers and officials involved, but it is becoming increasingly hard to deny the possibility that the extraordinary reluctance of our governments to force the unsecured creditors (and any remaining non-government shareholders) of the zombie banks to absorb the losses made by these banks, may be due to rather more primal forms of state capture. [More here]

Of course, the entire post by Willem Buiter is worth reading.