Reply to post: Re: While of course they needed to be bailed out

Re: While of course they needed to be bailed out

OzBob,

One of the problems of banking/capitalism that Tim doesn't cover in this article is that banks are pro-cyclical.

This means that instead of countering booms and busts, they inflate the booms and worsen the busts. So during the height of the boom, when they should be saying "oh dear this is looking too bubbly, let's wind our necks in and borrow less" - they actually lend more - as that house is bound to keep going up in value for the next ten years...

Then the bust comes. And now they won't lend to anyone unless they can prove they don't actually need the money, however good their business plan or credit is. They get all cautious, having just had their fingers burnt in the preceeding boom. So they shrink their balance sheets in order to become more solvent, but this reduces the money supply, and the credit avaiable to the economy to pay for growth and investment.

Regulation often makes this worse. Because the regulators are under political pressure to rein the banks in. And so during this recession our governments were making banks expand their fractional reserves (to make them more liquid) and raise more capital (to make them more solvent). This was for good and understandable reasons. There's an argument to say that they should have told the banks that they needed to have these larger capital buffers by about 2015, but were allowed to run less safely before that. But it would be pretty politically indefensible, and took a risk - that's pretty much what the Eurozone did - they stuck their heads in the sand, then had to bail out Greece to the tune of nearly €300 billion in order to save the German and French banks who'd recklessly lent to them. They also then implemented the bailout incompetently, fucked up the Greek economy in the process, and are now blaming the Greeks for their own (and Greece's too) massive clusterfuck, such that the Greeks can't pay, the banks are off the hook and the governments have put themselves in the firing line.

Anyway an example of counter-cyclical measures would be unemployment (and some other) benefits. Because these are paid out automatically, the government will pay out more of them as joblessness increases, and pay falls, during a recession. These are called automatic stabilisers. The government now spends loads more during recessions, something that didn't happen in the 30s, and this helps to keep the economy from cratering - and makes the recessions shorter and less painful.

There's an idea to make banking regulation counter-cyclical. So that in the boom times, they'll have to maintain a higher fractional reserve or capital adequacy ratio. Thus meaning they can't lend as much, and stoke the bubbles as hard. Then when the recession comes, the pressure will be released somewhat, in the hopes they'll now be more willing to lend, having sustained smaller losses from the collapse of the boom, and having more money on hand. In a big scary recession like the recent one, that probably wouldn't work. But it might have made the 1990-91 recession a lot less steep, for example.