Re: [Pen-l] Another Greenspan Gem

["Jim Devine" <jdevine03@xxxxxxxxx>]

Greenspan:
> "There are some who would argue that the role of the bank supervisor is to
> minimize or even eliminate bank failure; but this view is mistaken in my
> judgment.  The willingness to take risk is essential to the growth of the
> free market economy .. [i]f all savers and their financial intermediaries
> invested in only risk-free assets, the potential for business growth would
> never be realized."

He's right, but in this passage totally ignores the role of excessive
risk (which is what the supervisors are supposed to prevent). In
addition, there's an "adverse selection" problem that AG ignored in
practice, If one bank takes excessive risks, it gets a higher return
(until the bubble bursts). This punishes the banks taking only
reasonable risks, pushing them to take excessive risks... As the
bubble inflates, the mood shifts over to that of trying to stop taking
risks right before the music stops to get the highest possible return
(to use Keynes' analysis).

AG and his fellow travelers almost always ignore the complex
interactions among banks outside of the simple "ideal market" price
mechanism. Another interaction that's relevant today is the contagion
effect: if one bank fails, it makes other banks look bad, encouraging
them to fail. The bubble pops. (BTW, Downey Savings -- a long-lived
savings & loan institution -- just bit the dust. I bet that other
banks are failing right now without much ballyhoo...)
-- 
Jim Devine /  "Nobody told me there'd be days like these / Strange
days indeed -- most peculiar, mama." -- JL.
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