The Central bank can police the internal workings of its regulated banks. It can look at the repo'ed portfolio a bit at a time, by sampling. Remember the commercial banks receive liquidity from short-term (weekly, in the ECB's case) repos. An asset that was accepted last week can become unacceptable next week, or experience a higher haircut.

It's a bit like quality control or customs inspections. You don't want to inspect every item in every box in every container but if you sample and do find a faulty item you can quarantine an entire shipment pending further investigation.

Evidently, running the discount window properly would require a lot more manpower than banking supervisors currently deploy...

Economics is politics by other means

That's a feature, not a bug. As the system works today, the central bank (or the Treasury, but that comes to the same thing) ends up footing the bill for bad lending in any event. Might as well put them in the loop.

On the other hand, if the central bank imposes a 10 % haircut for the bank on top of the 20 % margin it forces on the borrower, it can probably make do with rules of thumb for most asset classes. Few houses are 28 % below their official valuation even in a deep crisis. They might drop 28 % below the bubble value, but the CB would only be on the hook for 72 % of the official value. The rest would be margin - something that would, in itself, discourage bubbles.

- Jake

Friends come and go. Enemies accumulate.