Thursday, November 26, 2009

WHAT TOO BIG OUGHT TO MEAN.

An amendment to the Financial Stability Improvement Act (currently before the House Financial Services Committee):

..." would empower federal regulators to rein in and dismantle financial firms that are so large, inter-connected, or risky that their collapse would put at risk the entire American economic system, even if those firms currently appear to be well-capitalized and healthy."

Some have proposed thus to limit each single bank to 1%, or 2% of GDP. This is not enough, not to say outright naive.

Indeed, however small, if the banks all conspire, and are all allowed to invest in the same non productive derivatives, they will still divert capital away from the real economy to imaginary profits justifying indecent and damaging bonuses, while starving the real economy.

The notion of integration in the mathematical sense has to be introduced. This is a known problem with carcinogens. To limit each given carcinogen below a threshold is not enough. By piling up carcinogens under the threshold, one can get large carcinogenicity. Thus Germany has introduced an overall integrated carcinogenicity limit. France, and the EU will soon follow suit (under scientific pressure).

So, by analogy, what should be limited is the overall risk to the system, and that should evaluated by checking how much risk is in the global system. An obvious way out is to regulate derivatives by limiting leverage, certifying each and every single derivative, and distinguishing commercial operators from speculators (who should be more limited in leverage).

Patrice Ayme
http://patriceayme.wordpress.com/