Tuesday, April 08, 2008

The magical hand

Alan Greenspan, in a Bart Simpson style "I didn't do it" interview with the Wall Street Journal (subs. req'd) --

WSJ: Do you believe there has been a problem with how bank capital requirements are set?

Mr. Greenspan: Financial institutions need little capital except when a crisis arises. Since we can't forecast the crisis, capital needs to be available at all times.

That's just incorrect. If banks don't have capital, then they're just gambling 100 percent with other people's money. The effect on incentives is obvious. Making banks maintain capital keeps some of their own money on the line and forces them to be more careful.

It's weird that an acclaimed economist doesn't see that incentives can be a big problem.

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