Kind of a weird thing for you to say, Tip. I hadn't figured you for a member of the paranoid camp.
I don't understand why what Greenspan said is freaking people out. "Creative destruction" is a term coined by an economist named Schumpeter, who is widely admired as someone who defended capitalism and entrepeneurship during the 1930's, a time when Marxism had considerable vogue among intellectuals worldwide.
>>Capitalism's creative ability, Schumpeter argued, is only half of its success story. Just as capitalism builds up new modes of production, so too does it perform the less popular but equally necessary task of eliminating and disbanding obsolete industries. Schumpeter termed this the "creative destruction" of the free market:
"The opening up of new markets, foreign or domestic, and the organizational development from the craft shop and factory to such concerns as U.S. Steel illustrate the same process of industrial mutation - if I may use that biological term - that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism." <<
gmu.edu
The statement that no bank should be perfectly safe is also quite accurate. Businesses depend on banks for loans to do business. That is one of the essential functions of banks. Without loans, business cannot function. Same thing with mortgages. Without banks, none but the very rich could buy real property.
Making loans entails risk. No matter how well-intentioned a borrower is, unforeseen circumstances may lead to default, or require restructuring. If a bank never took risk, it would not loan money. It would simply act as a storehouse - and then it could not pay interest to the depositor, because the interest the bank pays to lenders comes from interest that borrowers pay to the banks. The bank keeps some and pays some to depositors to attract deposits. That's how banks work.
If bankers think they can loan money without risk, then they won't be careful about whom they lend to.
If depositors think that banks will always be bailed out, they won't care whether their bank is sound.
That's known as "moral hazard." Bad business decisions are made due to the belief that nothing bad will happen because someone will bail you out.
The "moral hazard" problem isn't cut and dried. A temporary liquidity crisis can trigger defaults by otherwise solvent borrowers that would otherwise not occur in the normal course of business. A temporary liquidity crisis can be caused by any number of events, a default by a borrower further up the chain or changes in exchange rates, for example. The entire purpose of the Fed is to prevent temporary events from spiraling out of control, triggering an avalanche of defaults. The term used is "lender of last resort."
Put in a nutshell, a large customer defaults, and the bank is temporarily short of cash, although it has a portfolio of good loans which are not due. Alternative 1 is for the bank to call all the callable loans, which will seriously inconvenience, or worse, the businesses which have call loans. Alternative 2 is for the bank to get some sort of bridge loan from another bank, which has extra money lying around, and continue business as usual. Alternative 2 is vastly preferable.
In times of great crisis, banks work together for the good of all of them, and all of us. And the Fed is the place banks go to when things get really bad and they can't cope by working together.
Take the LTCM fiasco as an example. I gather from your comments that the Fed should have let LTCM fail, and default on $30 billion in obligations. That would have triggered a spiraling avalanche of defaults which would have led to bank failures worldwide. When banks fail, depositors don't get their money back. In the US, the FDIC would have had to compensate all insured depositors in failed institutions. Would you care to explain why that would have been better? Because I just don't get it.
It appears from the BIS website that the BIS is working to rein in speculation in derivatives and force banks to be transparent and accountable about derivates in their portfolios. The US, of course, is a member of the BIS and the Fed is working with the BIS. So it's not as if the problem is being ignored.
bis.org
One could make an argument that we should not have central banks. But we do. I think it is worthy of mention that the nation's economy and the world's economy seem to be more stable and prosperous than they were before central banks came into vogue. That may be a coincidence, or maybe it's not a coincidence. I don't see any brilliant economists arguing for the abolishment of central banks.
I'm not a fan of central banks, myself. I prefer laissez-faire capitalism, nature red of tooth and claw. Caveat emptor. It's kind of hard on the little guys, though, they have a tendency to get crushed. So we have the nanny state, and nanny banks. But that's the way it is.
Feel free to think you could do better than Greenspan. I won't agree with you.-g- |
