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Why Are There So Many Banking Crises?: The Politics and Policy of Bank Regulation

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This is an interesting,but incomplete,set of essays written by Jean-Charles Rochet and a number of co-authors which are based on the standard views of analyzing the banking industry's interest rate risk problems -asymmetric(incomplete or partial) information,adverse selection,moral hazard,and income gap(duration gap),value at risk models that seek to maintain bank capitalization levels in the face of banking industry attempts to minimize interest rate risk.Thus,"..improperly chosen risk weights induce banks to select inefficient portfolios and to undertake regulatory arbitrage activities that might paradoxically result in increased risk"(p.6).The alleged " solution " appears on p.250-"...adoption of "market-based" risk weights,i.e.,weights proportional to the systematic risks of these assets measured by their market betas..."(p.250).THe problem is that all of the essays are written on the misbelief that the normal probability distribution can be used to model risk.There is no attempt to deal with the equally important problem of uncertainty,in the sense of Keynes,Ellsberg and Knight,or the " wild " risk that Mandelbrot has shown is of paramount importance.The VAR models all assume normality,as do the beta results calculated from the CAPM .
The major objection is that,while the authors are aware that the commercial banks are continually attempting to sidestep the regulatory apparatus by " securitization",they don't draw the fundamental conclusion that was already arrived at by Adam Smith over 230 years ago-commercial banks can not be allowed to make loans to projectors(Keynes's stock and financial market speculators and rentiers),imprudent risk takers,and prodigals.If loans are extended to these categories of borrower,the result will be the destruction and waste of the aggregate savings of a nation.The depositors' money must only be loaned out to those individuals who will use the money loans to produce actual goods,services,and create jobs.Otherwise,the necessary investment needed intertemporally to maintain full employment and economic growth will not be forthcoming and the country will be subjected to severe economic problems-inflation,deflation,or stagflation.None of the essays reach this fundamental conclusion that follows from the ancient wisdom of Adam Smith.