This is the Cato Daily Podcast for Monday, November 28th, 2011.

I'm Caleb Brown.

Elaborate financial models have replaced myriad human judgments in so much of banking,

and that supplanting of human assessment helped set the stage for the financial

crisis.

So says author and Cato Institute adjunct scholar Kevin Dowd.

We spoke about how banks are told to value capital and how bankers game that system at the Cato Institute's 29th annual monetary conference held November 16th.

You've written about risk-based capital standards and other capital standards that international regulators

foist upon banks basically telling them you have to have so much here, so much here and so much here in terms of your portfolio

in order to have an adequately tolerable level of risk over your entire portfolio. Now you talk about the old system

was a system of just assigning risk weights to various groups, various kinds of investments.

And before we get into the problems of the new system, what were problems with that system?

Well, the old system involved completely arbitrary risk weights.

So it said basically that a commercial bond

had a 100% risk weight, an OECD government bond

had a zero risk weight. think about Greece which is a zero

default risk now so that old system was never reformed the Greek government debt

still has a zero risk weight under this approach to capital

adequacy requirements. That encouraged the banks massively into sovereign debt, which is one of the key problems of the Eurozone crisis.

Everybody's holding, the banks are holding too much government debt.

And we have a new system that is based less on arbitrary in that sense that is you're just saying this is worth 20%, this is 100%, this is 0, of a model that designates risk weights that sort of move around with various

indicators that people use to judge the risk. Exactly, under

...