Banking Failures — Letter to Krugman

I wrote the following in response to Krugman’s column regarding the stubbornness of those who continue to resist financial reform.

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I’ve recently been reading E.T. Jaynes’ “Probability Theory: The Logic of Science.” From the Bayesian point of view, effective arguments identify evidence that is probable in one scenario but not in the other.

In this case, I suggest the argument should be about the practical competence of today’s bankers, not the philosophical competency of the private sector in general. Leave to the side the perennial debate about the generic advantages of private vs. public sector management of capital. Compare today’s bankers with bankers of the past.

The evidence is pretty clear that today’s bankers know substantially less than their predecessors regarding:

— who is creditworthy and who is not

— how much risk their institutions can bear

— how to profit without jeopardizing the financial system

These are the fundamental requirements of competent banking. Therefore, the evidence suggests today’s bankers are incompetent. The problem we face as a society is thus: what do we do with an incompetent banking class?

It is at this point, and not before, that the role of government should enter the discussion. Given an incompetent banking class, should the government intervene in the management of financial institutions. If so, how? If not, what else do we do?

There may be good evidence that government will have a limited ability to solve the problem, but, when the argument is made in this way, such evidence does not in any way undermine the more fundamental proposition that our bankers do not know what they are doing.