Profits and Losses

Here’s a letter I recently sent to the New York Times:


Amar Bhidé argues that “governments should fully guarantee all bank deposits — and impose much tighter restrictions on risk-taking by banks.” (“Bring Back Boring Banks,” Jan. 4).

The lure of profit is why banks take on risk in the first place. But the specter of loss encourages them to be prudent about it. When governments remove losses from the equation, banks lose any incentive to keep their risk-taking in check. Someone else will pick up the tab if a plan doesn’t work, so why not take a chance? Hence the financial crisis.

Capitalism is a system of both profit and loss. Wishing losses away would have consequences quite different from Bhidé’s good intentions.

Washingon, Jan. 4, 2012
The writer is a fellow at the Competitive Enterprise Institute.

5 responses to “Profits and Losses

  1. I fear you may be confusing depositor’s incentives from banker’s incentives. My proposal does indeed dull depositor incentives — they have no reason either to pick the most prudent banks (or because of deposit rate caps) to pick the riskiest ones. As it happens depositors’ capacity to observe prudence is extremely limited — and in fact if lending is done in a proper Hayekian way (as I argued in my book, A Call for Judgment) a banker’s prudence ought not to be observable to outsiders. Thus inside regulation is key.
    Think of brake maintenance. There is no way you can tell whether the 18 wheeler next to you on the highway has properly maintained brakes (or a sober driver for that matter). And there is no market solution to this problem either. You have to count on the state to do this for you.
    As far as the prudence of bankers (as opposed to depositors) is concerned, my proposal does practically nothing to sharpen or dull incentives.

  2. Thanks for the clarification, Amar. I believe you are correct about my confusion. Mea culpa.

    I would point out that the lack of a market solution doesn’t mean, therefore, the state must act. Sometimes it does, of course. But sometimes it doesn’t. It depends on the facts on the ground. Harold Demsetz called that automatic assumption the Nirvana fallacy.

    I may not entirely agree with your piece, but I’ve learned from it all the same. Thanks for writing it, and I’ll take some time to check out your book.


  3. With the fallback position that fractional banking provides, The risk is either magnified or minimized, depending on which end of the Ponzi stick someone is on. Compound that delusion with taxpayer funded bailouts, and you get zero restraint. Let’s not allow Congress and the bureaucracy to escape judgment. Budget deficits should be paid out of their salaries and pensions. That would put a stop to that noise.

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