Generic commentary on banking structure and credit risk

I see no reason why lending banks should be separate from investment banks. Rather the depositors’ money should not be risked in either. It is also a mistake to blame Wall Street chicanery. Chicanery is a fact of life, and Wall Street has more than its share. But I can testify, from a ringside seat, that many sound financiers and first-rate economists genuinely believed in the sub-prime derivatives they were selling. They were proposed to the trusts I run. ] turned them down as a business proposition because | saw too much complexity and no upside. But my read was that the presenters were sold themselves. The problem is not in the people. It is in the inherent fragility of deposit-and-lend banks. Then what would the world be like without them? The answer first needs a closer look at the problem. Credit Risk is More than Leverage Some leverage is a good thing. Firms issue bonds as well as stocks in order to attract a wider range of investors. Risk-averse investors may choose the safety of bonds, whose interest claims are paid first, while risk tolerant ones may be happy with the iffier but more promising equity remainder. Leverage in general is a way to satisfy both these constituencies. Credit risk rises with term (duration) as well as amount of debt. One of the most telling points in Siegel’s Stocks for the Long Run is that corporate bonds of 15 years or more have proved more volatile in real total return than equities have. No wonder. A corporate bond will have ample debt coverage (gross profit/debt service) at date of issuance, and an appropriate credit rating. What will both be fifteen years from now? Homeowners also typically borrow long-term. They expect to have children in local schools, husbands and/or wives in local jobs, and other roots in the community. But Chapter 8 Banks, Money and Macroeconomics 2/8/16 2 HOUSE_OVERSIGHT_011091