Grits and Tamales

Life in the Deep South, by Gabriel Aguilera

On Profit-padding bank stabilization

“Profit-padding regulation” was coined by Rosenbluth and Schaap (IO, 2003). I’ve just built on this to say “profit-padding bank stabilization,” which I think is more descriptive of what we are talking about. This, by the way, is the card President Obama has chosen to play in the U.S. in the wake of the current crisis.

The idea is that you buy up banks’ bad assets and you drop rates close to zero. Big banks raise their fees and gauge consumers (and students), they make big profits. Now, in theory, this provides big banks incentives to not do stupid things (i.e. take on excessive risks), since they are making big profits in order to get healthy again. However, it seems that banks are doing stupid things and demonstrating lots of hubris, egging on the likes of Senators Warren, Caldwell and McCain to introduce tougher regulation to reduce their risky behavior (bankers are thumbing their noses, btw).

Why might they be doing this, hubris and stupidity aside? [It has been famously pointed out in what has become a cliche for political scientists that stupidity is never an interesting analytic category] One possibility, which should be sending chills up our spines, is that banks are “gambling for resurrection” because  banks are still in rotten shape, essentially bankrupt or barely profitable, and are being kept afloat by a combination of accounting magic, regulatory forbearance, easy money, and the fact that there is something of a modest recovery underway. Think of the gambler who has lost all his cash and has moved on to the credit card to try to make up what he has lost.


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