Turning Back the Financial Clock
Now you could in theory go back to having much more on balance sheet intermediation (finance speak for “dial the clock back 35 years and have banks keep pretty much all their loans”). Conceptually, that is a tidy solution, but it has a massive flaw: it would take a simply enormous amount of equity to provide enough equity to all those banks with their vastly bigger balance sheets. We’re having enough trouble recapitalizing the banking system we have.
Raising the ratio of capital to assets in the financial system is not a flaw. It’s a necessary adjustment.
Really, this is the fundamental argument about the future of the financial system. Should it look like 2007, with a wiz-bang new regulator for “systemic risk”? Or should it look like 1967, but with better controls over interest rate risk and more commitment to stable inflation (given my previous posts, the words “more commitment to stable inflation” are a bit difficult for me to believe in). I prefer 1967. Wall Street doesn’t. We know who is going to win that one, don’t we?