Tuesday, 2 September 2008

The Functions of Capital

It occurred to me as I was sweeping up the fallen leaves from my Hebe this afternoon that the marxist critique of capitalism would be stronger if it included the destructive effects of leverage. After all capitalism implies a duty to maximise ROE, and doing that requires leverage. But too much leverage gives you a banking crisis.

Partly these observations were motivated by a very fine article on Naked Capitalism. It points out that regulators still seem to be struggling with three evident truths:
  • The need to address information asymmetries in securitisation while preserving the risk distributions benefits it offers;
  • The importance of anti- rather than pro-cyclical capital requirements in promoting financial stability; and
  • Banks will always play capital games to maximise their ROE while appearing to be well capitalised and it is regulators duty to stop them.
If these three are not obvious to the supervisory community then there will be another crisis.

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