More Risk or Less

Gary Gorton wrote a 20,000 word paper I’d been meaning to read since Ben Bernanke represented it. Ezra Klein did a summary, though, so I didn’t actually read it. Gorton’s main contention is that moving forward we need to make the “shadow banking system” more like the regular banking system, in which there are explicit government guarantees paired with regulation.

I totally follow the logic of this, but I think it’s dead wrong for the reasons Felix Salmon lays out:

In my view of the crisis, it’s precisely the demand for informationally-insensitive assets which is the problem. And we need to get individuals, companies, and institutional investors out of the mindset that they can do an elegant little two-step around the inescapable fact that anybody with money to invest perforce must take a certain amount of risk. If you have a world where people are all looking for risk-free assets, you end up shunting all that risk into the tails. And the way to reduce tail risk is to get everybody to accept a small amount of risk on an everyday basis. We don’t need more informationally-insensitive assets, we need less of them.

That seems right to me. The combination of FDIC insured bank accounts and treasury bonds seems to me like an adequate supply of safe savings vehicles for the people who need them. People sitting on huge pots of money have perfectly good reason not to want to accept the low interest rates involved in those vehicles. But the price you pay for higher returns is more risk. But more risk should be acceptable to people with larger pots of money. What’s needed is for more time and energy to be put into people thinking about what kind of risks are worth bearing, instead of all this time and energy being put into trying to “engineer” the risk away. I think Gorton’s proposal would amount to basically shifting the engineering function out of the private sector and onto regulators, but this seems much more likely to wind up concentrating the risk at the tale (what if the regulators massively screw up?) than to actually make it go away.