Scott Sumner on how banking regulations create more risk

See On the uncertainty of our judgement. Excerpt:

"Banking: We have a major banking crisis in 2008 because lots of commercial loans went bad. We are told that banks need to invest in safer assets, such as government bonds. Silicon Valley Bank does this and goes bankrupt when yields rise and bond prices fall.

This is why government regulation is not well suited to solve problems such as excessive risk-taking caused by moral hazard. If commercial loans are too risky, and government bonds are also too risky, what’s left? You could have a perfectly safe “narrow bank,” but the Fed refused to give a banking license to an entrepreneur who tried to create a bank that invests all its funds with the Fed.

We (meaning pundits and regulators and politicians) think we understand the banking problem, but we don’t. We have created a system that almost completely socializes the liability side of bank balance sheets. Without market discipline, banks have little incentive to behave responsibly. We then assume the solution is “regulation.”  

How likely is it that regulation can solve our banking woes? Consider the following analogy. Give me a book on “How to be a General” and have me go up against someone like Alexander, Hannibal, Napoleon, Patton, etc. How likely is it that I’ll succeed? Now give a young inexperienced government bureaucrat a book on how to regulate banking and have them go up against J.P. Morgan.

Good luck. 

P.S. Matt Levine has an excellent post discussing the difficulty of regulating banks. He points out that even the most basic questions are difficult to answer. No one even knows whether higher interest rates are good for banks or bad for banks."