Oh Dear

Nice to see old Adam quoted of course, but perhaps not to support this point.

By losing sight of the purpose of investment, its practitioners have succumbed to the illusion of wealth. This is why it is time to rebuild a new financial architecture on firmer bedrock, not simply patch up the old one with more regulation and public subsidy.

This will mean a much smaller banking industry than Britain, particularly, has been used to. But it will also release thousands of our brightest minds for more productive employment.

Yes, governments should do what they can to minimise the pain of transition. Some good companies will go to the wall along with the bad, but we must not lose sight of the need for lasting change in our economic priorities.

Those banks that remain will not be able to use leverage to inflate their importance in society. As Adam Smith suggests, we may be surprised to find that there is plenty left behind upon which to build our future prosperity.

Smith of course spends several pages pointing out the advantages of fractional reserve banking and of leverage. Indeed, he concludes that it\’s a vital part of the wealth creation process.

Bankers justified their use of leverage by pointing to sophisticated "risk models", which showed they could cope with the odd loss. The fact that they haven\’t shows not just that the risk models were wrong but that the profits made possible by leverage were not real.

Well, sorta. Bad risk models, most certainly, but that doesn\’t mean that all profits from the use of leverage are not real. It means that those made by leverage supported by those bad risk models were transient.

It was that mispricing of risk which was at fault, not the much more basic (and desireable) concept of leverage. After all, there were and are banks out there that were just as leveraged but with better risk models….and they\’re doing just fine.

 

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