Today's Financial Reading
By Arnold Kling
There is a substantial economics literature on the effect of gender on attitudes toward risk and most of it appears to support the idea that men are less risk averse than women in their financial decision making.1 There is also a sizable literature documenting that men tend to be more overconfident than women. Barber and Odean (2001) find that men are substantially more overconfident than women in financial markets. In general, overconfidence is not found to be related to ability (see Lundeberg et al (1994)) and that success is more likely to increase overconfidence in men than in women (see, for example, Beyer (1990)). Thus, if confidence helps produce successful outcomes, there is more likely to be strong feedback loop in confidence in men than in women.
As I’ve said before, if I were the regulatory czar and told to curb risk-taking at banks, the one factor I would like to control is the gender of the CEO.
Second, Gary B. Gorton writes,
bank charters were valuable because of subsidies, in the form of limited entry into banking, local deposit monopolies, interest-rate ceilings, and underpriced deposit insurance. In other words, bank regulation not only involved the “stick” of restrictions (reserve requirements, capital requirements, limitations on activities), but also the “carrot,” that is, the subsidies.
His thesis is that banks take fewer risks when their charters are more valuable, and that their charters are more valuable when there are barriers to entry and other subsidies.
I would argue, for example, that the January 2002 revisions to bank capital regulations eroded the value of the Freddie and Fannie charters. This was somewhat intentional. Bank regulators wanted to make it easier for banks to fund mortgages, so the regulators made it possible for private-label mortgage securities with high ratings to enjoy the low capital requirements formerly restricted to GSE securities. As a result, over the next few years, private-label securitization soared and the market shares of Freddie and Fannie fell. Those firms then responded by taking more risks, by delving into sub-prime mortgages.
1. Senior tranches of securitizations of approved asset classes should be insured by the government.
2. The government must supervise and examine “banks,” i.e., securitizations, rather than rely on ratings agencies. That is, the choices of asset class, portfolio, and tranching must be overseen be examiners.
3. Entry into securitization should be limited, and any firm that enters is deemed a “bank” and subject to supervision.
If the goal should be trying to restore the type of financial system we had five years ago, then Gorton may be right. However, I think that is the wrong goal. I think that the goal ought to be a smaller financial sector, with less overall leverage. I am willing to throw securitization under the bus. Gorton is not.
I think that for Gorton, the problem began with what he calls the “panic” of 2007 and 2008. For me, the problem began with the housing and debt bubbles, particularly in 2004-2006. In this instance, I agree with John Kenneth Galbraith, who in his Short History of Financial Euphoria sees the cause of financial crashes as being the euphoria that precedes them, not the events that trigger the collapse.