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I don't think we should ,so easily, dismiss sectors that don't pose a macro risk.
Regulators should make sure the free market is functional - and that doesn't make it less free - and protect consumers.
The first part,in theory, is easy enough but the second part is more difficult.If we accept that competition should, in some way, benefit our society then can we even call this race for profits competition? And isn't it the opposite of Darwinism when the players race for maximizing profits not survival? Sure in some cases the risks taken are "life threatening" but those are exceptions (more Darwin Awards than Darwinism) and in only some sectors.If we want to force Darwinism on the issue, I guess, we could see this as corporations being large predators and the consumer the prey.Sometimes the predators get hurt but not so much by other predators.
Went a bit offtopic there,to go back, the point that has to be made today about regulations is that regulations don't have to make the market less free, just like protecting fundamental rights doesn't make us less free (sure anarchy means a lot more freedom but that's pushing it a bit too far).The political debate shouldn't be about safeguards that ensure that the market functions well but somehow many went to extremes and forgot that.

Thomas Rekdal

This is a superb posting, and well argued. Judge Posner is absolutely right that the Darwinian concept of "fitness" applies only to adaptability to a particular competitive environment; it implies nothing about any broader notion of utility or "goodness." Therefore, insofar as there is an analogy between Darwinian struggles in nature and Darwinian struggles in banking (and, of course, there is, since Darwinian competition applies almost everywhere), we cannot conclude anything about the health of the economy from the health of banking.

So far, so good. But then Judge Posner again falls back upon the need for more governmental regulation of the financial services industry (the competitive environment in question). With all due respect, I think this is more a slogan than a solution. Regulators are involved in their own Darwinian struggles, which also have little to do with the health of the macro economy. I would rather see more thought given to involving the personal fortunes of bankers in the success of the banks they manage. This involves a nest of legal problems on which I would not be competent to comment. But Judge Posner would be.


All of this is vaguely familiar of an old line I once heard a while a back,"We're no longer the Liars, Frauds, Cheats, Thieves and Scroundels we once were; of course we can be unregulated or deregulated - TRUST US"! Or as it operated in the old Roman Market, "Caveat Emptor". Or as old American Farmers were to observe about "Foxes in the Hen house or pigs in poke". It just goes too prove "that the more things change, the more they stay the same"...

Regulation, is there any other way?


hm that's odd. Prof. Becker in one of his interviews on youtube said that banking is one of the most regulated industries. And also in his post about banking and regulation he says that one of the main problems with banking and corruption is over regulation, not lax regulation. An prof. Posner is advocating that financial sector is not regulated enough. Can you explain your disagreements ? Cause i think that we only need to check the facts- the laws in financial sector and compare the amount of laws in it with other industries. Can you explain and show us some details about real regulation in fin. sector? And explain why you two have different views on regulation? Can you also maybe in next post show how the incentives and bank behavior is changed because of those laws?


Good post by Posner. His assertion that banks are subject to lax regulation is unfounded. Banks are highly regulated and have been for many years, particularly commercial banks. Regulation of investment banks is catching up (e.g., Dodd-Frank), if it hasn't already. And Posner's call for more regulation fails to account for regulatory capture, a common regulatory failure acknowledged by Becker's accompanying post.


I really like you Posner. Thank you for doing the right thing :)


Gordon Longhouse

A good summary of the incentives inherent in banking and how they might bring about undesirable results.
Missing is any sence that there is in fact a public good in "maturity transformation" i.e. borrowing short and lending long, a major source of risk in banking. Many will not lend except on condition that they can obtain instant or quick access to their money.
Many will no borrow on terms that the bank may call the loan at a moment's notice. The result of the natural order of things is that some economically useful loans are not made and some capital is sterilised.
It is for this reason, among others, that governments around the world support banking by guaranteeing bank creditors (formally just depositors but that means pretty much everybody in reality) and in return regulating bank risk making maturity transformation possible if not absolutely safe.
Historically banking and bankers have been considered rather dull. Indeed they cultivated that image so as to give a picture of "soundness" to would be depositors.
It is only in the past 20 years or so that banking has come to be associated with predatory animals. Perhaps the good judge might have spent some time discussing how this change came about.

Terry Bennett

We welcome Judge Posner back to lucid territory; this almost makes up for the free will post. The incisive explanation of the Social Darwinist fallacy, which has taken others a whole book to expose, is a stellar example of the value we seek here.

While I agree that after all, this is the money, and we should not necessarily enact Mr. Herbert Spencer's Social Statics, I do continue to believe that something is lost when individuals are relieved of their responsibility. Depositors used to interview a potential bank and find out about the risks their money would face there. Now we 100% do not care, because the FDIC does that diligence for us and backs its work. This cavalier attitude then sets the tone for the cascade of risky behavior we recently saw from both bankers and customers.

On the upside, the FDIC enables banks to tap into a broad base of capital from small, cautious investors who might not trust a bank without this insurance, and enables those cautious customers to avail themselves of modern banking services. Perhaps if the FDIC insured 90% or 95% up to its cap, reestablishing the depositor as an actual stakeholder, this would introduce a sufficient impetus for diligence to rebuild the culture of fundamental skepticism and vigilence by all parties that also once served us well in this crucial sector, without totally scaring people away.


I really like the Darwinian analysis, and I think that Posner is dead-on to note that competition selects for competitors who adapt to the particular environment. However, with respect to competition in the banking sector, there are a couple of very important aspects of that environment which Posner glosses over: non-risk-adjusted deposit insurance, and the political reality of "too big to fail". Bankers who take more risks, like any other other businessman who takes more risks, will see a greater variance in their results - more big successes and more big failures. However, deposit insurance and government bailouts cut off the fail tail of the distribution, so that banks engaging in riskier behaviors will have a higher expected ultimate return than those engaging in less-risky behavior.

Bankrutcy law has this effect generally (as does the reality that one can't lose more than one has), but the banking industry has a higher floor on losses than in other industries due to the implicit bailout guarantee, and the lack of risk-adjusted pricing for deposit insurance. Imposing some sort of risk adjustment to deposit insurance raters would impose some costs on riskier behavior, but only to the extent that the actual arrangements managed to capture the actual risks of risky activities, especially new ones where the risk is difficult to quantify. But eliminating the political baliout guarantee will be difficult to do in a credible way, without actually letting a large bank fail, and dealing with the economic mess that creates.


The financial industry is highly regulated, which means that Judge Posner's analysis is incorrect. The federal government, since the 1970s, has bailed out creditors, which distorts the markets because creditors do not feel the pain from lending to risky borrowers. In the latest "crisis," the federal government bailed out investment banks, insurance companies, and automobile manufacturers, which further distorts markets. In the 1990s, the federal government began a policy of encouraging home ownership by setting unrealistic targets for the GSE's ownership of sub-prime lending, which created artificial demand for residential housing and financial instruments that facilitated further investment in residential housing. Political goals and incentives have no basis in reality and lead to unsustainable booms, corruption, and fraud as everyone tries to make money where there is no real consumer demand. Using private institutions to facilitate political goals is corporatism or political cronyism. The wisest policy is to end the federal government's policies of bailing out creditors and using them to facilitate political agendas.

Ariadne Etienne

The fact is that lack of regulation, good regulation, is what we have and this is allowing financial catastrophes to occur. If business was smart they'd realize that good regulation helps keep the economic machinery from over heating, and ultimately, from breaking down. You don't drive your car at top speed everywhere you go, and you certainly don't drive it if you're low on oil. This is what has been done to the economy to the point where it has blown up, burned out, and disintegrated. A stable economy, one that is well regulated, provides the maximum opportunity for the maximum number of businesses to operate, and in this age of interdependence it is critical that this stability be ensured to keep the economy from running off the rails. From my experience there isn't a single rational or credible rebuttal, unless you're willing to risk everything, including your life, your business, and the entire planet to make a buck. Only a sociopath would take such a risk and we all know where these people should be locked up.


The Darwinian analysis is appropriate but fails to account for the true environmental adaptation made by the banks. Bankers knew they would never be required to pay a price for their bad investments. The adaptation would have been entirely different if the failed investments forced them out of business. The most crooked and dishonest bankers rise to the top when the price for bad investments is removed.


This article makes very little sense.

Under ordinary conditions, there's no such thing as "fitness" or "goodness" in the business world. There is only profit and loss. The businesses that make a profit survive, and the businesses that lose money cannot survive.

However, government intervention in the banking industry has created a situation where profit and loss no longer determines whether an institution will survive. For example, in order for a bank to survive it needs short term deposits. Ordinarily, the depositors would demand some level of fiscal responsibility from the bank or they would take their money elsewhere. Now, however, depositors never scrutinize where they put their money because they know it will be protected by Federal deposit insurance. As a result, the banks are given free rein to act recklessly with these deposits and can take risks that they otherwise would not be able to take if the depositors were not guaranteed their money would be returned. (The same dynamic happens every time the Federal government guarantees a loan. See student loans.)

It is Federal intervention in the banking industry - not the free market - which causes the moral hazard. The solution should not be more Federal intervention. The solution should be to remove Federal government intervention altogether, and let the free market work.


Judge Posner points out that banking generally requires "borrow[ing] short and lend[ing] long." but this article fails to follow through on the implications.

With few exceptions, Banks never have enough capital to survive a run no matter how prudent they are. This is precisely because of the mismatch between the liquidity of their deposits and loans. Long experience over more than a century in multiple countries show that in a bank run, prudent and careful banks fail as much as adventurous ones.

It is true that depositors are less likely to lose confidence in a bank which is run prudently. Nevertheless, it is also the prudent course of every depositor to retrieve his money immediately at the first hint of any trouble, however unfounded we know these might be. This is true even if we know perfectly that the bank is fundamentally sound, and that acting irrationally in this way jeopardizes the bank, and hence probably our own deposits. We want to be first in the queue during a bank run.

This is the Tragedy of the Commons writ large. In a game theory type analysis, banks are an unstable equilibrium. It is the recognition of this, and their vital roles as financial intermediaries, that governments everywhere in the 20th century have stepped in to provide some sort of depositor guarantee.

Given this, i.e. that no bank will survive a bank run, banks have sensibly been "cautious borrowers and lenders" only in the sense that they should choose borrowers who would be (in the long run) able to repay their loans with interest.

I agree with you that believing that markets are "self-regulating" is a fallacy. In street markets all over the world, food sellers are generally quite happy short-changing or short-weighting their customers. When there is "cheating" going on, choices cease to be commensurate, and both buyers and sellers lose out in the long run.

However, it is empirically not true that market forces drive out cheats abandoned by their enraged customers. This is partly because given the perverse incentives in such a system, everyone is cheating to different degrees but also because it is generally quite impossible to distinguish honest or reliable sellers from those who most successfully disguise their dishonesty.

This is true for banks as well. How easy is it for even sophisticated depositors to assess the financial prudence of their bank? Is it possible to weigh such risks against, for example, an increased return (interest rates)? What are the practical costs of such a suspicious approach?

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