Poor Problem Solving

Brantley Foster: "Look at this! They send requisitions through two departments to get procurements for a third. What kind of thinking is that?"
Fred Melrose: "That's suit thinking. Something happens when a man puts on a necktie. Cuts off all the oxygen to his brain."
--Secret of My Success

President Obama continues to demonize financial institutions for taking 'excessive risks' and thus in need of more regulation.

To the extent that the president's claims stem from sincere analysis, rather than from political grandstanding (which of course is certainly questionable), then this demonstrates poor problem solving process.

If we accept the claim that risks taken by banks et al were indeed excessive, then effective problem solving requires us to ask why these firms took excessive risks. "Because they weren't regulated" doesn't answer the question. Regulation is a potential remedy rather than a cause.

Risk of the type we're considering is related to leverage. Depending on the type of institution, leverage ratios range from about 10 to 1 for retail banks to 30 to 1 or more for investment banks. Leverage requires borrowed capital which requires lenders of capital.

The question, you see, becomes who is willing to lend capital to these highly leveraged institutions? All roads lead to the Fed and other central banks.

Another potential cause? These institutions know that the system is set up to bail out poor decision making. Bailouts in terms for their frequency and magnitude have have been escalating over the past 25 yrs. And they happened again in spades over the past two years. When decision makers know that someone has their back for decisions gone awry, then they take more risk. This is what is known as moral hazard.

Want to wring excess risk taking out of the system? Eliminate below-market rates of credit as manipulated by the Fed. And get out of the way of market forces that drive inefficient operators to failure.

Neither of these, of course, is politically acceptable to this administration.