In a recent NYTimes blog entry, Paul Krugman brings up the shortcomings of the purely competitive market model for healthcare. These same informational economics issues apply equally well to the banking crisis. While the idealized old fashion banking model relied on trust, the modern model is based on extreme forms of competition. At the same time, modern banking is regulated and protected by the government. Pure Competition and Government Regulation are two extremes, and the ideal falls somewhere in the middle.
Um, economists have known for 45 years — ever since Kenneth Arrow’s seminal paper — that the standard competitive market model just doesn’t work for health care: adverse selection and moral hazard are so central to the enterprise that nobody, nobody expects free-market principles to be enough. To act all wide-eyed and innocent about these problems at this late date is either remarkably ignorant or simply disingenuous.
Jon Taplin comments on a Deloitte study on ROA vs ROE:
My friend John Seely Brown just sent me a report from his Deloitte Center for The Edge called The Shift Index. They make no attempt to hide the bad news for the U.S. Economy–“return on assets for U.S. companies has steadily fallen to almost one quarter of 1965 levels,at the same time that we have seen continued, albeit much more modest, improvements in labor productivity.” The meaning of this is staggering–any productivity gains from the digital revolution have been more than wiped out by our corporate (as well as personal) addiction to debt. To understand this, it’s important to grasp the difference between return on equity (the classic Wall Street measurement) and return on assets.
This NYT article (5/3/09) on Lehman’s Commercial Real Estate group gives a picture of how a star banker and a few investors (with large portfolios) can have a great influence on a particular market sector, and how a high flying group can influence overall profits at a large financial institution.
How Lehman Brothers Got Its Real Estate Fix – The New York Times
The FED’s stress test was run in March and April on the top 19 banks which hold two thirds of all assets and half of loans in the US banking sector. The tests are explained in this document: The Supervisory Capital Assessment Program: Design and Implementation. The average baseline and more adverse alternatives for 2009 and 2010 used were:
The WSJ reports on the results: U.S. Presses Some Banks to Act After Stress Tests – WSJ.com
Read the transcript of William Black’s recent testimony on derivatives before the Committee on Agriculture, Nutrition & Forestry of the United Slates Senate: Prepared Testimony of William K. Black Associate Professor of …