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- Economist.com | WASHINGTON
- Financial markets
I HAVE to say, Martin Wolf has been earning his pay cheques during this crisis. On the subject of how to address banking problems in Britain and America, his work has been far more circumspect and insightful than that of a lot of other financial writers out there. He seems, for example, to be willing to grasp with the challenge posed by creditors of large, failing financial institutions. By rights, they should take a big hit, however the government chooses to respond to the crisis. But it's just not clear that the financial system can survive such a thing. Mr Wolf writes:
Why should not more of the losses fall on creditors, other than the insured depositors? That is the question asked by many economists. It is the approach recommended by proponents of a “good bank” solution.
The big point here is that the losses against which the government is now offering such generous insurance relate strictly to bygones. If we want banks to make new loans, it makes far more sense to guarantee those, rather than bail out all those who financed the mistakes of the past. So, suggest the radicals, toxic assets should have been left with the shareholders and uninsured creditors of the old bank, who would also gain a claim on a clean new bank. Moral hazard would disappear and taxpayers would be left relatively unharmed.
The arguments against this are two: first, the possibility of a default would create a wave of panic worse than the one that followed the bankruptcy of Lehman last September; and, second, for this reason, no individual government could dare to go it alone.
Unlike Professor Buiter, I recognise that these could be valid arguments in the current circumstances. I certainly have no desire to make the slump even worse than it is. But, if so, they have compelling implications.
One is that we must create effective mechanisms for orderly bankruptcy of very large financial institutions. Indeed, this is far and away the most important lesson of the crisis.
I don't agree with everything he has to say. I'm not at all convinced, for instance, that getting the banks to make new loans should be a policy priority. There are limited good lending opportunities available right now, and there are plenty of good banks out there for when opportunities improve. But Mr Wolf correctly identifies the key issue—we have no good institutional mechanism to allow these kinds of financial firms to safely fail.
But compare Mr Wolf's work with that of Paul Krugman, who has a new column up today.
Think of it this way: by using taxpayer funds to subsidize the prices of toxic waste, the administration would shower benefits on everyone who made the mistake of buying the stuff. Some of those benefits would trickle down to where they’re needed, shoring up the balance sheets of key financial institutions. But most of the benefit would go to people who don’t need or deserve to be rescued.
And this means that the government would have to lay out trillions of dollars to bring the financial system back to health, which would, in turn, both ensure a fierce public outcry and add to already serious concerns about the deficit. (Yes, even strong advocates of fiscal stimulus like yours truly worry about red ink.) Realistically, it’s just not going to happen.
So why has this zombie idea — it keeps being killed, but it keeps coming back — taken such a powerful grip? The answer, I fear, is that officials still aren’t willing to face the facts. They don’t want to face up to the dire state of major financial institutions because it’s very hard to rescue an essentially insolvent bank without, at least temporarily, taking it over. And temporary nationalization is still, apparently, considered unthinkable.But this refusal to face the facts means, in practice, an absence of action. And I share the president’s fears: inaction could result in an economy that sputters along, not for months or years, but for a decade or more.
There is a great deal of point-missing in these paragraphs. Mr Krugman suggests that the way to avoid spending trillions helping the banks, and rewarding those who wrecked the banks, is to nationalise them. But nationalisation doesn't make the debtholders go away. Would the government make them whole, or simply give them a minor haircut? If so, then you still have a situation where the government is spending trillions of dollars and rewarding people who don't deserve a reward. Or would the government simply say, sorry debtholders, you're stuck with the losses? That would save taxpayers a lot of money and strike a major blow against moral hazard—but only if it didn't precipitate a Lehman Brothers-like meltdown.
If Mr Krugman hopes to convince me—and, I suspect, if he hopes to convince those with their fingers on policy levers—he needs to address this question. So far, he's taken the easy way out, asserting that Ben Bernanke and Tim Geithner don't get it, and are just too chicken to nationalise."Me:
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