Thursday, 1 April 2010

The Fallacy of Banking Regulations

Banking regulations intended to avoid bank risks and other economic activities that “caused” the current financial crisis completely miss the point, but they are also wrong and naïve in themselves too. I’m not going to discuss the causes of the crisis on detail, I have done a poor job explaining them here (read Tom Wood’s Meltdown for a better understanding). What I will do, however, is show that these regulations are stupid and they only advance the special interests by making politicians look as if they’re taking responsible action for problems they have actually caused themselves.

In essence, banking regulations claim two things:

a) Banks are irresponsible and childish; we have to teach them about risk

b) We’re so good we know what is and what isn’t risky

Let’s take each assumption separately. The idea that banks somehow don’t understand that their actions have consequences is a completely ludicrous one. The idea that government should tell banks that their investments can be risky is like me telling someone that tomorrow it will either rain or it won’t. Banks and individuals are not retards to be instructed about such an obvious truth! Instead, another more important question has to be asked: Why did so many banks, make so many bad decisions, within such a short time? How could so many banks afford to take so much risk? There must have been an underlying cause or push for this to happen. And there was. In short, it was the easy credit from artificial credit expansion by the Federal Reserve through loose monetary policy that provided the necessary credit for banks to expand. If it wasn’t for the Fed, banks wouldn’t even have the money to make risky investments! It was Fannie and Freddie that artificially directed capital towards housing construction, created the boom and the inflated prices and attracted investment that wouldn’t have otherwise taken place. It was inflation, Fed machines printing more money from 2000 up to 2007 than the Republic had printed in its entire history that created the necessary platform for banks to take risks. Easy credit is the keyword, and when the banks are sitting on abundance of reserves provided by the Fed, it’s only natural that they will take more risks than otherwise! Banks don’t need to be taught about risk, they know that pretty well. What they need is to be able to lend only what was given to them in good faith (abolish fractional-reserve banking) and be allowed to float in the free market profit-and-loss mechanism (no bail outs).

Second, these regulations claim that somehow the government will find the Supermans who know what is and what isn’t a risky investment. I’m really curious to know who these people are, because I’m ready to hand over every asset that I own to these gods so that they can invest it for me. There are no such people that know for sure what is and what isn’t risky! In fact, the best speculators, investors and bankers are there working privately, not for the government. Mises said that every choice belongs to the future, and since future is uncertain, there is always a level of speculation in every decision. To think that the government has the absolute knowledge over what is a good and a bad decision is pure illusion. Remember, we’re talking about the same government which among others runs Securities and Exchange Commission which failed to catch Bernie Madoff for over 30 years and employs people like Ben Bernanke who said the “fundamentals of the economy are sound” right before the crash. The government cannot do anything properly because it works outside the fundamentals necessary to do things properly. Government’s very attempt to centrally plan money is no different than Soviet Union centrally planning the rationing of goods such as milk. To give this monster more power to exercise over people is to exacerbate the causes that brought us over to such an idea like “regulations.”

The only possible “regulation” that can work is the one that limits the tools and interference areas that the government has access to. The need for something like “regulations” only emerges as a result of government’s failure to plan the monetary system. What is needed is radical banking reform, not regulations that only change the morph of the ugly face that government intervention is.

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