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Yakk · 01-16-2009, 02:38 PM

Ace, individual optimizing actions do not generate globally optimal results in a general free market.

That is because Nash equilibriums that are not global maxima exist in most cases.

The hope is that the system is set up so that Nash equilibriums exist close to the global maxima, so we can use each individual processing information and making decisions in their own best interest to generate a good approximation to the global maxima solution, far better than a central resource allocation could do.

The problem is knowing where the global maxima is challenging. On the other hand, it can be easier to see isolated Nash equilibrium failures and fix them without knowing what the global maximum solution is (ie, you see a situation where action X done by all parties would create efficiency, but action X done by any one party would result in the externalities being captured by other parties. That results in no party having an incentive to individually do action X. A regulation enforcing action X on all parties that costs less than the projected benefit is worth exploring, in order move the Nash equilibrium, and hopefully find a better hill to climb.)

Naturally, these experiments can be dangerous -- misestimation of cost of enforcement or return from the policy, or the possibility that the costs cause other more-ideal equilibriums to fall into worse states, can cause damage.

The idea of bank regulation is that having companies able to generate market-responsive liquidity, and who have internal incentive to evaluate the worth of people who want cash, is a useful thing for society. But the internal incentives don't line up perfectly -- banks have lots of short-term and medium-term incentives to "bet against the black swan" event. A bank that failed to bet against the black swan would see lower returns on their investments in a systematic way. It would fare better in a catastrophic downturn -- but the damage from that downturn wouldn't be limited to the banks who did bet against the black swan, and the 'cautious' banks would suffer a good chunk of the economic damage that the 'reckless' banks generated.

So the idea is that we allow banks to do term-inversion of investments on reasonably large scales in exchange for being conservative in their investment actions. The reserve requirements exist so that the bank can survive a black swan event without collapsing. (The damage caused by a bank collapse is not just limited to bank creditors, account holders, and investors -- due to the economic lubricating job of the bank, it creates far-flung damage that is external to agreements directly with the bank and bank counterparties.)

Anyhow, that is how I see it.

01-16-2009, 02:38 PM	#38 (permalink)
Yakk Wehret Den Anfängen! Location: Ontario, Canada	Ace, individual optimizing actions do not generate globally optimal results in a general free market. That is because Nash equilibriums that are not global maxima exist in most cases. The hope is that the system is set up so that Nash equilibriums exist close to the global maxima, so we can use each individual processing information and making decisions in their own best interest to generate a good approximation to the global maxima solution, far better than a central resource allocation could do. The problem is knowing where the global maxima is challenging. On the other hand, it can be easier to see isolated Nash equilibrium failures and fix them without knowing what the global maximum solution is (ie, you see a situation where action X done by all parties would create efficiency, but action X done by any one party would result in the externalities being captured by other parties. That results in no party having an incentive to individually do action X. A regulation enforcing action X on all parties that costs less than the projected benefit is worth exploring, in order move the Nash equilibrium, and hopefully find a better hill to climb.) Naturally, these experiments can be dangerous -- misestimation of cost of enforcement or return from the policy, or the possibility that the costs cause other more-ideal equilibriums to fall into worse states, can cause damage. The idea of bank regulation is that having companies able to generate market-responsive liquidity, and who have internal incentive to evaluate the worth of people who want cash, is a useful thing for society. But the internal incentives don't line up perfectly -- banks have lots of short-term and medium-term incentives to "bet against the black swan" event. A bank that failed to bet against the black swan would see lower returns on their investments in a systematic way. It would fare better in a catastrophic downturn -- but the damage from that downturn wouldn't be limited to the banks who did bet against the black swan, and the 'cautious' banks would suffer a good chunk of the economic damage that the 'reckless' banks generated. So the idea is that we allow banks to do term-inversion of investments on reasonably large scales in exchange for being conservative in their investment actions. The reserve requirements exist so that the bank can survive a black swan event without collapsing. (The damage caused by a bank collapse is not just limited to bank creditors, account holders, and investors -- due to the economic lubricating job of the bank, it creates far-flung damage that is external to agreements directly with the bank and bank counterparties.) Anyhow, that is how I see it. __________________ Last edited by JHVH : 10-29-4004 BC at 09:00 PM. Reason: Time for a rest.