What with crises and all, I thought I should refresh my basic grasp of the issues by perusing an economics textbook. Chapter 13 of Macroeconomics by Paul Krugman and Robin Wells concerns the monetary system. It includes the following “check your understanding” question:
A con man has a great idea: he’ll open a bank without investing any capital and lend all the deposits at high interest rates to real estate developers. If the real estate market booms, the loans will be repaid and he’ll make high profits. If the real estate market goes bust, the loans won’t be repaid and the bank will fail—but he will not lose any of his own wealth. How would modern bank regulation frustrate his scheme?
Having read the chapter, the correct answer is that modern banking regulations involve capital requirements that don’t let you do this. Having watched the past six months unfold, the real answer seems to be “not very well!”
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