Sunday, 1 November 2009

Prudent bankers - self regulation - and Mediterranean yachts

A recent posting at Seeking Alpha contains the following citation from a speech made by a professor of Economics at George Mason University on how we need a new rule of law to prevent financial crises in the future

"If it is known that nobody is “too big to fail”, or too well connected to fail, then lenders will not let financial firms leverage up cheaply in the belief that they will be protected."

The statement sounds very reminiscent of the doctrine that the free market is capable of regulating itself because the self-preservation interests of the relevant lender's shareholders will encourage prudent behavior. This is more or less the same doctrine which Alan Greenspan admitted not so long ago, in testimony to Congress, was his big misconception.

The problem with this laissez faire mythology is that the interests of the managers/traders/financial engineers at the big lenders are not aligned with those of the shareholders. Much of the decision making of the business lenders/financial firms is conducted by guns for hire who can have moved on to pastures new (including yachts on the Caribbean/Mediterranean) by the time that their imprudent lending judgments become evident

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