Monday, April 06, 2009

Getting it backwards

I like Megan, but this article made me laugh:
If you can't or won't read the notes to a 10-K or 10-Q, you should not be investing in bank stocks. Let me put that another way. IF YOU CAN'T OR WON'T READ THE NOTES TO FINANCIAL STATEMENTS, YOU SHOULD NOT BE INVESTING DIRECTLY IN STOCKS.
Cool, we are on the same page. Next:
But we are not doing this to fool investors; we're doing it because of regulatory capital requirements. The problem with things like reserve ratios is that while in theory they should be countercyclical, in practice they aren't.
By reserve ratios, she almost certainly means capital requirements. The notion that reserves somehow constrain lending is completely wrong, and is at the heart of all the ineffectual monetary policy littering the financial landscape today. Bank lending is constrained by capital requirements on the supply side, and quality borrowers on the demand side, with the driving factor today being on the demand side.

Also, capital requirements (what Megan means when she says "reserve ratios") are NOT countercyclical in theory. They are PRO-CYCLICAL in theory, which is great because they are also PRO-CYCLICAL in practice. The notion that credit extension drives the economy is the biggest fraud that the financial sector has perpetrated on us, and has everyone from the Obama administration on down believing that you need to FIRST fix the banks to THEN fix the economy, whereas in real life, restoring aggregate demand to the economy FIRST would "magically" "fix" the banks. "Magically" because no one would understand how helping consumers save will help restore aggregate demand, and "fix" because banks aren't broken, they're just pro-cyclical and the cycle is against them right now.

Maybe you need to understand banking, capital requirements, reserve requirements, and aggregate demand as well as reading 10-Ks and 10-Qs to the necessary qualifications for investing in banking stocks.


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