In his speech yesterday, potential Governor of the Bank of England Paul Tucker discussed moral hazard, agency problems, short-termism and the “manifestly false” assumptions of risk models. I almost feel prophetic.
He also said:
When credit markets become overly exuberant, not only do the balance sheets of lenders become stretched, cheap credit leads borrowers to become over indebted, raising the probability of default. When defaults eventually pick up, a general awakening occurs, triggering mass deleveraging.
So close to the monetary theory of the trade cycle but so far. If we can now just move the debate towards recognising that it is monetary policy which stimulates over exuberance in credit markets, we’ll really be getting somewhere…
It’s good that the idea of reforming incentives for banks is being taken seriously by people like Tucker. Let’s hope Osborne etc are listening!
At present, with private banks in control of the money-supply, the system is unstable. It could be made inherently stable by giving control of the money-supply to an independent body, and tying it to the price index/purchasing power of money. Would it not be great if economics became a science ! It is only 2012.