Timmy ElsewhereOctober 7, 2008 Tim WorstallTimmy Elsewhere8 CommentsSpeccie. OK, now I\’m worried. On liberals and liberals. previousPolly TodaynextBritblog Roundup 190 8 thoughts on “Timmy Elsewhere” Matthew October 7, 2008 at 12:43 pm Could you expand a little on your plan for an exchange for bank loans – in particular how it would guard against default and ensure confidence was retained? Tim adds: Not my plan. Willem Buiter’s. Tyler Cowen’s suggested something similar for credit derivatives and swaps. The basic point is very simple. The exchange becomes the counter-party, thus removing default risk. Matthew October 7, 2008 at 1:16 pm But Willem Buiter’s is that the central bank takes on that role. Yours is that it will be a private sector entity, which is the bit I don’t understand. Tim adds: Probably because I haven’t thought about it very much. There are plenty of such private sector bodies taking that role. “Clearing Houses” is the usual name I think. the LME has one, there are various bond ones, Lloyd’s the market is one (it guarantees against default by a member firm or name, doesn’t it?) and so on. Whether it would work with inter bank lending I’m not quite sure….but then I’m also not quite sure how the BoE would function either. Ed October 7, 2008 at 3:10 pm The basic point is very simple. The exchange becomes the counter-party, thus removing default risk. Call me pedantic, or else ignorant of how such an exchange works, but how does this _remove_ default risk? Surely it just transfers the risk of the particular bank failing to the risk of the exchange as a whole defaulting? One would hope the latter would be a lot less than the former, but perhaps not if there is a systemic problem. Recent history suggests we are not that good at pricing distributed risks. David October 7, 2008 at 3:49 pm Passive smoking does not harm children? Not even young babies? What about cot death and smoking? http://www.fsid.org.uk/smoking.html Matthew October 7, 2008 at 5:06 pm I don’t understand it either. On a futures exchange typically the contracts are marked-to-market and margin is posted, minimising the exchange’s risk. In Tim’s idea however the exchange would be providing enormous loans (and taking in enormous deposits) and so it seems to me to just be a mega-bank. gene berman October 7, 2008 at 7:28 pm Ed: The observation about not being very good “at pricing distributed risks” is quite accurate but does not consider that the pricing process, a more or less mental judgement balancing perceived risk factors, is one in which there are—or may be—a number of unseen “thumbs” on the scale, each of which may be interpreted as increasing or decreasing risk and some of which are introduced by regulation and its somewhat spongy applicability and enforcement. When one becomes aware of the fact that the man behind the curtain derives his power from an ability to delude those on the other side as to the extent of that power and, moreover, one knows neither the extent of that power nor the willingness of the “man behind the curtain” to wield any or all of it, one may certainly be forgiven inaccuracy in risk assessment—but not for playing such game in the first place. It’s one which, for some time, rewards guilty and innocent winners while penalizing guilty and innocent losers, hardly affecting those uninvolved. But, sooner or later, while penalizing the same general groups, it lets a fair few of the guilty–both winners and losers “off the hook,” while assessing the uninvolved–even as spectators—for the losses. We all know “caveat emptor.” But why should those who haven’t been emptors have to caveat? Why should anyone have to pay who hasn’t bought? The reason is actually simple. You “buy” into the game when you assent to (or insist on) regulation. Without regulation other than the usual against fraud or force, “players” can do what they will and the uninvolved can remain so. Vote for the regulators—and you’re involved. like it or not—and you’ll suffer whatever is their inaccuracy or misjudgement in “assessment of distributed risks” along with those who don’t. It’s a fool’s game but we’re all playing it, whether we like it or not. Ed October 8, 2008 at 11:11 am It’s a fool’s game but we’re all playing it, whether we like it or not. Gene, this reminds me of C.P. Snow’s description of the Laws of Thermodynamics: You can’t win, you can’t break even, and you can’t get out of the game! An exchange for inter bank lending may be a good idea, but it depends upon who is running it and what incentives they have. The most obvious question to me is will this exchange make it easier (aka cheaper) for risky or highly leveraged banks to borrow more money? I would hope the opposite would apply, but doubt it will, whether the exchange is privately owned or run by the central bank. On that subject, I doubt the exchange can ever be truly private because what government will allow it to fail? gene berman October 8, 2008 at 2:46 pm Yes, Ed. It’s all simply a reminder that, along with all the other humorous oxymoronic expressions, ought to be included not only the word but the very thought “foolproof.” In my original comment, I was intentionally “breezy” and not really very careful with the outlines of my analogy (it’s not the regulators with their thumbs on the scales but some of the bolder “regulated” who stick their toe in the water and (if its neither bitten off nor scalded) go on to more, bigger, and better. But, in responding to your comment, I actually neglected to explain (not necessarily to you) what is a compounding difficulty with the idea of “risk” and, conversely, how it is we shall try to “insure” against such by the setting aside of a reserve fund to indemnify against the various and sundry eventualities which might occur to require those funds (including the eventuality that one such might occur which had never occurred to those considering the matter). Long or short, the answer is that the matter is almost entirely entrepreneurial and, therefore, “out of the pay grade” of officials or other employees, no matter the type nor extent of their expertise. No amount of “past experience” rendered as statistical data provides any more than the most nebulous idea of what the future holds in regard to certain anticipated “maybes,” let alone those unanticipated. “Can I insure with you and pay you now and right along so that, if something really, really bad happens, I’ll get my money back?” “Sure–no problem.” “What happens if it’s so bad that I’m not around to collect?” “Can’t see the slightest difficulty with that–no problem for you at all.” “What happens if it’s so bad that you’re not around to make good?” “Can’t see where I’d have the slightest problem with that, either.” “Great. Sign me up!” The truth about such matters is that the very existence of regulation creates boundaries, below which are practices beneath attention or difficult to identify. Sometimes a “crackdown” identifies current malpractice, punishes some for “exemplary” reasons, then returns to “business as usual.” The likelihood is simply that length of oversight experience accumulates a stock of below-the-barrier weakness while the very longevity of surface placidity reinforces a notion of “soundness” and, likely, a tendency toward oversight laxity combined with growth of the previously acceptable zone of risk. Not too many things in this world dependent on human behavior can accurately be described as “inevitable.” But the idea that crisis regularly follows regulation comes close. Leave a Reply Cancel replyYour email address will not be published. Required fields are marked *Comment Name * Email * Website Save my name, email, and website in this browser for the next time I comment.