Don’t be so sure that bank profitability heralds anything positive about the economy. Lending is still anemic, the deal economy is slouching toward NoMoreAh and the profits are coming because government backing makes nearly free money available to banks.
In a column in the Financial Times yesterday, Harvard Professor Kenneth Rogoff explains:
…it is dangerous to point to the nascent restoration of profits in the financial sector as clear evidence of a corresponding benefit to the economy. There is an element of arbitrage, as banks borrow at low rates against the implicit guarantee of a government bail-out in the event of a crisis. Do people really believe, as some argue, that moral hazard is a non-issue? Why should large systemically critical financial institutions be allowed to heavily leverage themselves with short-term borrowing? What would be lost if regulators placed stricter capital requirements to discourage arbitrage activities that excessively expose too-big-to-fail banks to systemic risk? Certainly economists have models of why it can be efficient for lenders to keep borrowers on a short leash. Yet these models do not explain why the leash has to be wrapped around borrowers’ necks three dozen times, as in the case of a highly leveraged bank.
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