Thursday, February 12, 2009

Mistrust (3)

Increased regulation is not the answer. Regulation cannot make dishonest people honest and greedy people generous. Regulators cannot eliminate temptation and they cannot eliminate the risk of default. Regulations make the situation worse, because they encourage people to trust regulated activities, when it would be better for them to mistrust them.

The only solution is to go back to mistrust. Lenders must recognise that some borrowers will be unwilling or unable to repay their loans. Banks need to get back to doing all the things that they did in the past when dealing with borrowers that are not completely trusted. Credit checks, guarantees, collateral mortgages allow savers to lend to people they mistrust, by managing the risk of default.

When savers go back to mistrusting banks, they will start monitoring their activities and looking for banks that are running less risk. Savers should follow the example of the people who queued outside Northern Rock, because they had heard that the managers of the bank had been engaging in risky practices. We need more of this behaviour.

If I have ten gold coins, who would I trust to look after them. I would trust my wife, my adult children, a few of my friends, some of the members of my church, but that is about it. Gold coins can be melted, so proving ownership is very difficult. If I am going to give them to anyone else to look after, I would be wise to approach them with an attitude of mistrust. Only a fool would lend would blindly pass their coins on to anyone else to look after without putting in place a process to ensure that they will get them back. We should approach banks in the same way.

People who mistrust banks will look for banks which will look after their money without shifting it onto the banks balance sheet and treating the depositors money as if it was their own. More mistrust is the key to a more stable financial system.

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