^^^^^ this is where the mentality of "leave the private market to itself" comes from.
unfortunately, it also spills over to banks and financial products which - in theory - should be the most efficient of all private institutions if "left alone", but the Alt+A debacle is a solid reminder of why we cannot leave financial markets without regulated checks and balanced.
i think 90% private market efficiency is about as good as can be expected while maintaining sensible regulatory control. after all, the CDO market was 110% efficient with no regulatory control, and now that entire sector is regulated it's non-existent.
There is a counter argument about how regulation has caused the crisis in the banking sector in the USA, Ireland etc. I personally don't believe in the following as some regulation is necessary to protect society from their own stupidity but should put it out there for completeness;
If the banks in the USA had not been regulated and bank failures in the past had not seen the establishment of deposit guarantees and government ran deposit insurance individuals depositing with banks would make the decision partly based on which was safe.
Those banks who had strong balance sheets and did not engage in risk taking would get more deposits than those who offered a higher interest rate but also risked depositors funds.
So the government in guaranteeing deposits allows bank to lever off the governments balance sheet to obtain funding even if their own balance sheets stink and their practices leave a lot to be desired.
The recent move on covered bonds in Australia is a shocking moral hazard and I can put my hand on my heart and virtually promise this will come back and haunt us possibly in the next decade but if not repealed (which will be difficult) it will eventually. Whenever you have a guarantee in place from the government it will be taken advantage of by those that benifit from the guarantee.
Put yourself in the position of a bank in Australia. You can with 8% capital over your deposit liabilities go to people and tell them I want to borrow money and you can guarantee them their capital back and 6.5% interest all guaranteed by the Australian government. Of course you are going to lever up with reckless ababndon only constrained by the 8% of your own capital. i.e. on every 100k of equity you have you can go and get 1.25million dollars to invest. Who wouldn't have a crack with that.
If you cannot make 6.5% investing it you are a mug right? and if you cannot or lose the lot you only lose your 8% capital anyway the rest comes from the taxpayer.
So the bank can engage in risk taking and the customer (depositor) does not even care, as they get paid either way. If it was a true market different banks would advertise say; 10% capital over deposit liabilities or perhaps 20% but with an interest rate of 3.5% etc. There would be choice and part of that choice is who is the riskiest. At present the choice for a depositor is simply, who has the highest rate of interest. Nothing else matters a jot.
My own opinion is there must be regulation in banking as you are saying and I don't mind sounding hypocritical around this.
As Chifley said banks are too important to be run by the private sector. I would not go this far but due to their connexion with the economy they need to be regulated to achieve slow and steady growth maintaining healthy balance sheets along the way.
The banks certainly should have minimum capital requirements be constrained on the method of valuation of their assets be they risky or otherwise. All this regulation they have now but the government should not be guaranteeing their funding nor allowing them to issue bonds covered by these guaranteed deposits and worse now contributing a component of their funding. It is going down a path that we already know the destination.
When it comes to investments created off the back of mortgages like RMBS, I will be buggered if I know why anyone ever buys them? You don't have bank capital shielding (well 8% odd is better than nothing) you from a loss and yet they pay the same interest as bank deposits. I guess this is why the government has had to step in and take up a swag of these RMBS as people are wising up to the fact being on the banks balance sheet is better than being off it. They actually care about who they lend to when they risk the loss themselves.
