Krugman- The Malevolent Ex-Maestro [View All]

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After playing a key role in creating the greatest economic disaster in three generations, you might have expected Alan Greenspan to lie low. But no, he’s out there issuing opinions, which for some reason still get listened to. Worse: he keeps calling for a return to the very regime he favored before, the regime that led to disaster.

Felix Salmon reads his latest, so we don’t have to. It’s terrible on all counts; but the most offensive thing intellectually is the incredible fallacy of claiming that higher capital requirements for banks amount to keeping resources idle.

Hello? Bank capital doesn’t consist of canned food or steel ingots held in a vault somewhere, and raising capital requirements doesn’t mean that food or raw materials have be stored in a bunker. All that’s happening when you increase capital requirements is that you are requiring that banks reduce their leverage, financing more of their portfolio from equity and less from deposits or borrowing. And this has nothing to do with resource use; it’s about the distribution of risk. Specifically, raising capital requirements means that if something goes wrong, more of the cost will be borne by the bank’s owners, less by depositors, lenders, and/or whoever (including the taxpayer) insures those deposits or loans.

It’s true that shifting the equation in this way will discourage risk-taking — but that’s a feature, not a bug. In case you hadn’t noticed, banks took too many risks in the past, helping land us in the mess we’re in.

The fact that Greenspan imagines that bank capital is like installing seat belts suggests that the man once revered as a demigod of finance doesn’t understand basic economics — or, more likely, that he chooses not to understand what he, amazingly, is still being paid to not understand.


http://krugman.blogs.nytimes.com/2011/07/30/the-malevolent-ex-maestro/