February 15, 2014

No Mohamed El Erian, nowadays, extraordinarily dumb bank regulators, are making it all so much worse.

Sir, Mohammed El Erian in reference to banks betting on risky emerging markets holds that “In some ways today’s financial sector is little different from the one I first got to know decades ago… Yet not everything has gone full circle. Regulators and shareholders no longer allow banks to make such risky bets, even though they hold more capital” “Emerging world fashions that change with the seasons” February 15.

What? He must mean regulators no longer allow banks to make such risky bets… because banks are allowed to hold so much less capital when lending to something perceived as “absolutely safe” and therefore have to go where they can earn so much higher risk-adjusted returns on equity.

Banks have always lent primarily to what they have perceived as safe and tried to avoid what seems too risky. The difference nowadays is that regulations are helping banks to build up even larger and more dangerous exposures to what is ex ante perceived as absolutely safe but that could, foreseeable, become very risky ex post… and, when that happens, bank will then be guaranteed to find themselves naked with no capital to defend themselves with.

In other words, not everything is the same, extraordinarily dumb regulators are just making everything so much worse.