as investors than other market actors optimally would be, if a “trust” constraint did not arbitrarily bind. But central to most banking-is-special stories is the idea that banks (not uniquely, cf “shadow banking” again) sometimes lend incautiously, into credit demand that does
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Replying to @interfluidity @stf18 and
Yes, I do make the assumption that banks are no more incautious than other creditors. My model assumes banks are better at making (some types of) loans. You want a model where banks are in a sense worse (in a social sense) at making loans. Let me think about this.
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The variations I proposed (issuing IOUs against no assets, accepting negative-expected-value loans) certainly sound socially worse, but that’s an artifact in part of sticking with a nonstochastic model. A better way of thinking about it might be to model investors’ projects as
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Replying to @interfluidity @dandolfa and
risky, and to model nonbank investors lending behavior as risk-averse. Then your “arbitrary” trust parameter can just be a risk transformation: nonbank investors perceive the bank to be riskless, regardless of its (opaque) portfolio. Then the “specialness” of banks lives in its
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Replying to @interfluidity @dandolfa and
er, lives in their ability to accept arbitrary risk, rather than in making loans that are bad with certainty. A bank might even be “risk-loving”: that is it might take on risk that, for an individual project, might have negative expected value. But even this need not be socially
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Replying to @interfluidity @dandolfa and
“bad”, because in reality investment projects are not independent. A banking system that is “risk loving” may fund an ecosystem of projects that each of would be wasteful in isolation but that in aggregate have positive expected value (cf “big push”). i think realistically, this
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Replying to @interfluidity @dandolfa and
is why fractional reserve banking systems have been such an effective accelerator of development, precisely because they make loans that prudent investors in isolation would be unwilling to fund.
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Replying to @interfluidity @dandolfa and
To be clear, I don’t think banks are special because they are necessarily “poor” investors, from a social perspective. I think they are special because they are free to lend in ways that other investors would not, because their liabilities are perceived as low-risk (in nominal
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Replying to @interfluidity @dandolfa and
terms) regardless. That does enable socially destructive pathological games: self-interested agents making loans that are just poor, the banking system as a whole converging on a strategy of maximizing the value of a put option offeref by the state. But we have fractional reserve
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Replying to @interfluidity @dandolfa and
banking because sometimes they use their liberty to extraordinarily good social effect.
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intentionally?
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