Tuesday, December 1, 2009

Propaganda Packages

Here is a propaganda package from The Bank of England just in time for Christmass. It sounds all stately and academic and all, but it's pure bullshit aimed at nothing more than giving academic cover for a concept that has yet to receive regulatory blessing, namely reducing capital requirements for banks.

The thrust of it goes like this: let's increase the capital requirements on banks during bubbles (bubbles which The Bank of England inflates) and decrease the requirements during bust years. Well since the paper came out after the boom has bust what does that really mean? Yup, you'll soon be hearing more and louder talk about reduced capital requirements.

To gain your confidence the propaganda piece begins seemingly innocently enough:
Increasing capital requirements in a credit boom would generate greater systemic self-insurance for the system as a whole and, at the margin, act as a restraint on overly exuberant lending.
But of course thses are not exuberant times so the paper suggests:
lowering capital requirements in a bust might provide an incentive for banks to lend and reduce the likelihood of a collective contraction of credit exacerbating the downturn and increasing banks’ losses.
The paper goes on to ignore the fact that lending during a bust should be restrained simply because fewer people and institutions can repay the loans.
Separately from seeking to address changes in risks through the credit cycle, capital surcharges could also be set across firms so as broadly to reflect their individual contribution to systemic risk. For example, as the FSA have discussed, surcharges could be levied based on factors such as banks’ size, connectivity and complexity. This would lower the probability of those institutions failing and so provide some extra systemic insurance. It would also provide incentives for those firms to alter their balance sheet structure to lower the systemic impact of their failure.
Allowing those firms who should fail to fail would provide the best "incentives for those firms to alter their balance sheet structure" and operational behavior so as not to fail.
A big practical question is whether a macroprudential regime with aims of the kind described above could be made operational. Capital surcharges would need to be calibrated. That would ultimately require judgement, drawing on analysis, market intelligence and modelling. This discussion paper summarises, by way of illustration, a few of the indicators, quantitative and qualitative, that with further work could become useful inputs. They would largely be about the macroeconomy, and the financial system as a whole and the interaction between them.
Allowing those firms who should fail to fail would be the most practical answer to that question and no futher calibration would be necessary.
It seems unlikely that macroprudential instruments could be set wholly according to fixed rules. Judgement may be needed to make robust policy choices. That would call for assessments of the resilience of the system, credit conditions, sectoral indebtedness and systemic spillovers — all of which vary over time and according to circumstances. All available evidence would need to be weighed, and policymakers would themselves need to adapt as they learn about the effects of their instruments on behaviour.
Allowing those firms who should fail to fail would be the best macroprudential instrument by which to make robust policy judgments.
But it would be important that constraints were placed on a macroprudential regime to ensure transparency, accountability and some predictability. That would call for clarity around the objectives of macroprudential policy, the framework for decision-making, and the policy decisions themselves. It also suggests the need for robust accountability mechanisms. Such a macroprudential regime of ‘constrained discretion’ would share some similarities with macroeconomic policy frameworks.
Do I need to repeat myself here? Letting them fail is the best way to ensure transparency, accountability and some predictability. Blow up and die and youre not around to screw anyone anymore.
Another important issue would be the degree of international co-operation. To be wholly effective, a macroprudential regime might require significant international co-ordination. But, even in its absence, appropriate macroprudential instruments might still be able to strengthen the resilience of the domestic banking sector.
Dum Dum I already told you what to do.

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