[Pen-l] Good bank, bad band

[raghu <mraghu01@xxxxxxxxx>]

Willem Buiter has been a voice of common sense throughout the past
year or so. He continues to make a great deal of sense in his latest
article:
http://blogs.ft.com/maverecon/2009/02/good-banknew-bank-vs-bad-bank-a-rare-example-of-a-no-brainer/
-----------------------------------------------------snip
The existing packages of support measures in the US, the UK and
elsewhere have failed to get lending to the real economy going again.
In the US especially, but also to some extent in the UK, It has been a
shameful boondoggle for the banks that are at the heart of the
financial mess - bank CEOs and other top managers, bank shareholders,
holders of unsecured bank bank debt (subordinated, junior and senior)
and other creditors.

The US, the UK and several other continental European countries are at
risk of emulating Ireland, where the government first guaranteed all
the liabilities of the banks (other than equity) and only after that
began to nationalise the banks.  This leaves the Irish government
today in the not too enviable position of having to choose between
sovereign default and bleeding the tax payer and the beneficiaries of
normal public spending to make whole all the creditors of the banks.

Bailing out the holders of existing bank debt and other bank creditors
would be outrageously unfair: they did the lending and made the
investments, they should eat the losses.  In addition, many of the
creditors are likely to be much better off, even after they write
down/off their claims on the banks, than most of the tax payers and
public expenditure beneficiaries that pay for the bail out.  Bailing
out the existing creditors would also create dreadful incentives for
excessive future risk-taking by banks.

Especially in the US, the disdain for moral hazard displayed since the
beginning of the crisis by regulators and by the fiscal and monetary
authorities has been shocking.  It has been justified with the claim
that you cannot afford to worry about medium- and long-term incentives
for appropriate risk taking when your  house is on fire.  That
argument is logically flawed.

Two things are systemically important.  The first is to restore the
operation of key financial markets that have become illiquid.  The Fed
is doing a reasonable job in that regard.  The second is to restore
bank lending to the real economy.   Neither objective requires that
the existing banks be saved, let alone that their existing
shareholders and creditors receive any financial support from the
state.  We can save banking without saving the banks or the bankers.
The 'good bank' proposal demonstrates how to do this.

Regulators, central bankers and policymakers should be pursuing three
key objectives.  The first is to get lending by the banks to the real
economy, especially to the non-financial enterprise sector, going
again. The second is to minimize moral hazard by creating the right
incentives for future risk taking by banks, their creditors and their
customers, by ensuring that the losses incurred by the failed banking
system are born first and foremost by those who invested in the banks
in any capacity.  For reasons that are partly sensible (protecting
small unsophisticated savers from financial ruin and forestalling
inefficient attempts by financial illiterates to monitor complex
financial institutions) and partly populist pandering, most retail
deposits have ended up insured or guaranteed by the state (often at
least in part ex-post).  Moral hazard should be stopped, however,
beyond the magic circle the state has drawn around retail depositors.
The third objective is to pursue justice in burden sharing.




-raghu.


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Now entering Iowa. Please set your clocks back 20 years.
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