Adjusting banking regulation for the economic cycle
Bankers have a bad habit of making economic cycles worse. They are notorious for lending people umbrellas when the sun is shining and asking for them back when rain starts to fall. When the economy is strong and asset prices are rising, banks are only too eager to lend to those wanting to buy assets, helping to push prices higher. In bad times, when prices are falling, banks ask for their loans back, forcing the borrowers to sell assets and driving prices down further.
Right now, banks are desperately plastering over the cracks in their balance sheets created by the credit crunch. This week Royal Bank of Scotland launched a £12 billion ($24 billion) rights issue (see article). Other banks have tapped the bulging wallets of sovereign wealth funds. But there may be a limit to investors' largesse: those who have bailed out banks so far have lost money.
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