links for 2008-02-14
Bernanke Testifies Again...

Martin Wolf Throws Up His Hands

"[W]e have a banking sector that has a demonstrated capacity to generate huge crises... we lack the will and even the capacity to regulate it. Yet we have no obvious alternative but to try to do so," says the gloomy Martin Wolf:

Why it is so hard to keep the financial sector caged: Consider, for example, the process that brought subprime loans to investors in special investment vehicles (SIVs). In between the ultimate borrowers and the risk-takers were loan-originators, designers and packagers of securitised assets, ratings agencies, sales staff, managers of banks and SIVs and managers of pension -- and other -- funds. Given the number of agents and the wealth of information asymmetries, it is astounding how little went wrong.... The US itself looks almost like a giant hedge fund. The profits of financial companies jumped from below 5 per cent of total corporate profits, after tax, in 1982 to 41 per cent in 2007, even though their share of corporate value added only rose from 8 to 16 per cent.... Yet can anything effective be done to contain the risk-taking this implies?...

The bigger point still, however, concerns macro-prudential regulation. As William White of the Bank for International Settlement has noted, banks almost always get into trouble together. The most recent cycle of mad lending, followed by panic and revulsion, is a paradigmatic example.... [T]he strength of the pressures against taking "away the punchbowl just as the party gets going", in former Fed chairman William McChesney Martin%u2019s famous phrase, is formidable. In addition to bureaucratic inertia, such action is subject both to unavoidable uncertainty about the dangers of current trends and to resistance from private interests. Furthermore, regulators are in constant danger of losing sight of the systemic wood for the institutional trees.... On the one hand, we have a banking sector that has a demonstrated capacity to generate huge crises because of the incentives to take on under-appreciated risks. On the other hand, we lack the will and even the capacity to regulate it. Yet we have no obvious alternative but to try to do so...

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