Why we have a banking system at all

Or, if you prefer, Brad DeLong\’s take on what the financial system can do for us:

  1. Trading money now for money later: people who want to save now and spend later can make win-win trades with people who want to spend now and save later.
  2. Risk: people who are unusually averse to risk in general can make win-win trades by trading off some of the risks that they are bearing to people who are unusually tolerant of risk in general.
  3. Insurance: people who are holding a lot of one big risk can reduce the risk of catastrophic loss by paying a great many others to each take a small piece of that risk.
  4. Information: people who have information that prices are going to rise can make win-win deals with people who have information that prices are going to fall–although here the win-win is not for the participants in the trade: for them it is zero-sum, and the winners are those others who observe the market price at which the trades occur.

I\’ve said before that I\’m not averse to different financial market regulation (which might be more or less than we have now). But that different regulation does have to allow those four things to be done. Which, sadly, a lot of the suggestions being made do not….or even deliberately rule out or make more difficult one or more of those four.

For example, the Robin Hood Tax would tax futures and options on their nominal value not the premium or option value thus making 2) either near impossible or hugely expensive.

One comment on “Why we have a banking system at all

  1. There are two types of regulation

    1) One which is heavily impacted by those experienced in the relevant business.
    2) Driven by politics, rather than need.

    The first one ends up being captured by those who are supposed to be being regulated, whilst the second does more harm than good, driven as it is by ignorance.

    How to find the combination of sector understanding with a disinterested outlook???

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