Turning Back the Financial Clock

Arnold Kling

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Yves Smith writes,

Now you could in theory go back to having much more on balance sheet intermediation (finance speak for "dial the clock back 35 years and have banks keep pretty much all their loans"). Conceptually, that is a tidy solution, but it has a massive flaw: it would take a simply enormous amount of equity to provide enough equity to all those banks with their vastly bigger balance sheets. We're having enough trouble recapitalizing the banking system we have.

Raising the ratio of capital to assets in the financial system is not a flaw. It's a necessary adjustment.

Really, this is the fundamental argument about the future of the financial system. Should it look like 2007, with a wiz-bang new regulator for "systemic risk"? Or should it look like 1967, but with better controls over interest rate risk and more commitment to stable inflation (given my previous posts, the words "more commitment to stable inflation" are a bit difficult for me to believe in). I prefer 1967. Wall Street doesn't. We know who is going to win that one, don't we?

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Latest Comment

q writes:

so, then, we would all be investing in bank equity and bonds (or holding company equities and bonds) rather than in securities that they produce.

interesting idea, but i don't see how that is any more transparent for the investor. perhaps better from other points of view?

another question i have: if you combine this, plus shut down the big banks and GSEs, and if you reduce the budget deficit to reasonable levels (ie stop printing more treasury bonds), how do you get foreigners to invest in this country? if you don't, wouldn't you expect much higher mortgage rates?

i don't know the answers to these questions, but they need to be clearly thought through. the old system wasn't good, but as they say in california, everything happened for a reason.

thanks.

Posted October 21, 2009 7:57 PM

MikeDC writes:

Couldn't we have a middle ground of, say, 1987, where banks still keep a larger portion of their loans and we don't have lots of 0 down loans out there, but we've still got higher growth potential?

OK, maybe 1987 isn't the best example year, but you get the point.

Posted October 21, 2009 8:58 PM

8 writes:

Does the end of Bretton Woods matter, can we go back to 1967 without global monetary reform?

Posted October 21, 2009 9:04 PM

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