Two essentially unreconciled views.
1. Markets can equilibrate, by themselves, as long as some participants can absorb evolving risks, even those they didn't anticipate.
2. Markets don't equilibrate, because the cycle of boom-bust drives cautious management out of business during boom, leaving shoddy balances sheets most or only, just before the bust.
'NO PAIN, NO GAIN' ECONOMICS
Those of us who look to the self-interest of lending institutions to protect shareholder equity have to be in a state of shocked disbelief. But I hope that one of the casualties will not be reliance on counterparty surveillance, and more generally financial self-regulation, as the fundamental balance mechanism for global finance.
BOOM-BUST ECONOMICS
Gone are the days when banks prided themselves on triple-A ratings and sometimes hinted at hidden balance-sheet reserves (often true) that conveyed an aura of invulnerability. Today, or at least prior to August 9 2007, the assets and capital that define triple-A status, or seemed to, entailed too high a competitive cost.
