We are now in a micromanaged economy

Interesting piece from Matt Levine on Bloomberg on Wednesday. It highlights how far regulators are now going to micromanage the financial system. They now prevent banks from lending to private equity firms (so-called ‘leveraged loans’), distorting lending mechanisms, market pricing and economic agents’ learning process. The whole scheme is subject to potential arbitrage and could possibly lead to even more devastating opaque financial engineering.

Some of my friends (senior bankers working in financial institutions mergers and acquisitions at other banks) recently told me that regulators prevent their clients (banks) from trying to acquire any other banks. Nonetheless, during the crisis, regulators almost forced, or at the very least engineered, banks mergers…Does anybody still believe we are in a free market?

This is a regulator:

The impact on private equity, a significant driver of what we see as risky practices, is an intended consequence of our actions,” Martin Pfinsgraff, the OCC’s senior deputy comptroller for large-bank supervision, said in an interview. “As regulators, we certainly hope to change bad practices and remove the extraordinary froth that’s experienced at the peak of a credit cycle. If we can mitigate that, it reduces the size of the valley to follow.

A suggestion to this person: why don’t you become a banker? It looks like you know better than bankers how to safely pick counterparties to lend to. Moreover, what he does not realise is that by restraining the flow of credit somewhere, it’s going to reappear somewhere else, shifting systemic risk to another (and possibly darker) corner of the economy.

Forcing banks: to add a bit of capital there and there and some liquidity here, to consider which assets are safe and liquid and which aren’t, to trade some products through specific counterparties, not to acquire competitors, to force the acquisition of competitors, and so on, was not enough. Regulators have now introduced another new tool and earned another power. Moreover, in their quest to make the banking system ‘safer’, regulators are likely to make it more vulnerable: banks will become less differentiated, holding the same types of assets, lending to the same types of clients, having the same types of internal models and engaged in the same types of trading activities. I let you guess what happens when those regulatory-favoured activities collapse.

Exactly 70 years after Hayek’s The Road to Serfdom was published, it looks like we’re back to the same point.

Photo: HR People