Bailouts versus responsibility

What we have seen in the last decade is
a near total elimination of the concept of
taking responsibility for your own problems,
versus making your problems everyone else problems
via a number of devices, one of which is the concept and practice of “bailout.”

Consider, for example, a New York Times story on the European Union.
In the story’s preliminary edition, on the web the day before,
the lead paragraph was
European Union finance ministers on Sunday
sought to forge a system that could
radically expand the bloc’s powers to raise funds
to keep troubled member states from going bankrupt,

as the specter of
more chaos in the financial markets on Monday morning loomed large.

There used to be a much simpler solution to problems such as this.
In this case, it would be:
Let Greece take responsibility for its own problems.
If German and French banks go bankrupt
due to the loans they made Greece which do not get paid back,
then bail out the depositors who would otherwise lose their deposits,
who are innocent of any misdeeds.
But the people and institutions
that made the financial decisions that led to this situation
should directly bear the consequences of their decisions.
Not the general public, be that European or American.

Miscellaneous Articles


U.S. suffers from same afflictions now causing turmoil in Europe
By Steven Pearlstein
Washington Post Opinion, 2010-05-19

[This is posted in both
The coming financial crisis” and
Bailouts versus responsibility ”.]


The moral we should draw from this European story is that
while government rescues may be necessary to stabilize markets,

there can be no real recovery until
the causes of the underlying imbalances are dealt with.

For the United States, those root causes are
an overvalued currency
a penchant for living beyond our means by
consuming more than we produce.


In European Debt Crisis, Some Call Default Better Option
New York Times, 2010-11-23


Ireland has finally taken its medicine,
accepting the financial rescue package
European officials have been pushing for several weeks.

But even as Europe moved to avert this latest debt crisis,
economists and policy experts are increasingly debating
whether it would be better, and fairer,
for the Continent’s weakest economies to default on payments to lenders....

IMF says response to global economic crisis
may have deepened some problems

By Howard Schneider
Washington Post, 2011-03-10

[Here the IMF experts essentially echo the points made above.
But they don't need to worry about getting elected by the American electorate!]

Governments in the United States and Europe
have failed to address some of the core problems
that sparked the recent financial crisis

and may have made some of them worse
by taking such extensive steps to rescue ailing banks and other companies,
the International Monetary Fund concluded in a study of
how the developed world responded to the near-shutdown of the global economy.
The unprecedented levels of public spending and central bank support for the economy helped prevent an even worse short-term downturn,
the IMF concluded
after comparing the crisis response in the United States and Europe
to the way Asian and Latin American countries responded to
their financial crises in the 1990s.

However, that rapid and large financial triage has not been followed by
the more fundamental sorts of changes needed to fully heal the financial system,
the study found, and may have given a false sense of confidence
that things are now all right.

In those earlier crises, more banks were allowed to fail or were forced to restructure,
and more was done to clean bad loans and bad assets out of the financial system.

But more than two years after the collapse of Lehman Brothers,
the IMF said much of the heavy lifting remains to be done -
even though the political impetus behind reform seems to have flagged.


Crisis Is Over, but Where’s the Fix?
New York Times Opinion, 2011-03-11

[Because this issue is so important, and because the IMF advice echoes, I believe,
the opinions I expressed back at the top of this document,
I am reprinting the column in its entirety below.]


When the financial system began to crumble more than three years ago,
the world rushed to rescue it.
Country after country went deeply into debt to keep banks afloat
and prevent a deep recession from turning into something worse.

It worked. This week was the second anniversary of the nadir of the crisis.
Most stock markets around the world are at least 75 percent higher
than they were then.
Financial stocks, which led the markets down, have also led them up.

At the time, rescuing seemed more important than reforming.
The world economy was breaking down because of a lack of financing.
Trade flows collapsed, and companies and individuals stopped spending.
It seemed clear that halting the slide was critical.

But the world has changed since then.
The economic recovery in most developed countries is stuttering at best,
and governments are struggling with their own finances.
It is time for remorse and second-guessing.

A surprising citadel of that second-guessing
is at the International Monetary Fund,
where researchers this week concluded that
the rescues “only treated the symptoms of the global financial meltdown.”

The researchers, Stijn Claessens and Ceyla Pazarbasioglu, warned that
“a rare opportunity is being thrown away to tackle the underlying causes.
Without restructuring financial institutions’ balance sheets and their operations,
as well as their assets — loans to over-indebted households and enterprises —
the economic recovery will suffer,
and the seeds will be sown for the next crisis.”

There have been reforms, of course.
The Dodd-Frank law in the United States is now being put into effect,
albeit by regulators that the new Republican majority in the House of Representatives seems determined to starve of resources to do the job.
Banking regulators around the globe have agreed that
much more capital is needed by banks,
but stricter requirements are coming very slowly out of fear that
abrupt changes will reduce bank lending when it is needed the most.

More capital is clearly needed, but it may not be nearly enough.
“If we ask them for more capital, and they are too big to fail,
they can take even more risk” after they raise additional capital,
Y. Venugopal Reddy, a former governor of India’s central bank,
argued at an economic conference sponsored by the I.M.F. this week.
He added that he was worried about
institutions that were “too powerful to regulate.”

One of the questions economists were asked to address at the conference was,
Does the financial system have social value?

A few years ago, that question would not have been asked at the International Monetary Fund.
If it had been, the responses would have been as unanimous as might be expected
if a gathering at the Vatican were to consider whether religion was a good thing.

Now, there is no such unanimity.
It is clear that
there are functions of the financial system that must be performed,
among them the allocation of capital and the setting of prices.
But there is at least a suspicion that
a significant part of modern finance has no real value for anyone
except the participants.

Adair Turner, the chairman of Britain’s Financial Services Authority,
spoke with wonderment of the huge volume of stock trades
now made by computers using algorithms to rapidly trade in and out.
Some traders, he said, were using what they called “predatory algorithms,”
whose sole purpose is to exploit a weakness in some other trader’s algorithm
and get it to make an unprofitable trade.

“It is quite difficult to work out the social benefit of that,” he said.

And of course, there is also the fact that
the financial system did not accomplish what it was supposed to do.
“At the core of these functions is
the ability to find and set the right price,
including the extent to which it reflects risk,”
Antonio Borges, an I.M.F. official and former vice chairman of Goldman Sachs International, told the conference.
“This is not really a question of financial sophistication,
of complex products or greedy bankers.
It is a question of getting the prices wrong.”

He added, “It is unbelievable how wrong they were.”

There is general agreement that
many of the assumptions economists and others made before the crisis —
about the rationality of markets, about their ability to measure risks
and about the proper role of monetary policy —
were largely wrong, or at best oversimplified.
But there is far less unanimity about what to do about it.
International cooperation was impressive in dealing with the immediate crisis.
Now it is splintering, and banks are threatening to move operations
to areas they deem friendlier to them.

In retrospect, it is clear that
the bailouts came with too little pain for those responsible.
Bondholders who financed banks that failed largely escaped pain.
That was true even in Ireland,
where the bailout would have led to a default of government debt
had Europe not stepped in.
It is still not clear how Ireland will pay its national debt,
but the bank bondholders did fine.

[This is an issue I raised in my early 2009 post,
Investment and Finance”.]

At the time, of course, there were fears that
forcing bondholders to suffer
would lead to the collapse of banks that could have survived.
Those fears seemed reasonable to me then, and still do.
But little progress has been made in setting up mechanisms to assure that
any future crisis can be dealt with in a different way.

There is talk of restructuring bank balance sheets to assure that
debt is automatically converted to equity
just when equity seems to be worth little,
but that is unlikely to happen unless regulators force it,
and it is far from clear what price investors would demand.

Moreover, as Mr. Turner noted, it is important to somehow assure that
those who would suffer from such a conversion
are not themselves so leveraged that a crisis would be intensified.
Something like that seems to have played a role in
Europe’s decision to avert a Greek national default.
Most of the Greek debt was owned by European banks,
and it was doubtful that they could afford to take the losses.

Perhaps the most important error made early in the crisis
was a decision by Henry Paulson, then the United States Treasury secretary,
to put pressure on big banks to accept bailouts whether they needed them or not.
The idea was to avoid making acceptance of such money a scarlet letter
that would in itself alarm depositors and investors.
It seemed to make sense.

But it also meant that it was not clear
which managers had led their banks over — or at least close to — a cliff.
There was an unmet need to establish the principle that, in Mr. Reddy’s words,
“When the profits are good, you take your bonus.
When something goes wrong, you go out and somebody else comes in.”

The principle is particularly important
because regulatory failures may be inevitable.
If multimillion-dollar bank bosses do not see a crisis looming
before it is too late,
can we be sure regulators who work for far less will be more prescient?
[That question answers itself.]
Markets clearly did a horrid job of allocating capital,
but there is no particular reason to think governments would do better.

Even if regulators somehow did design a perfect regulatory system,
it would not last,
simply because clever bankers would eventually find ways around it,
just as people find ways to evade taxes,
forcing tax law writers to constantly make changes.

“Every decade or so,” said Paul Romer,
a senior fellow at the Institute for Economic Policy Research at Stanford
and now a visiting professor at New York University,
“any finite system of financial regulation will lead to
systemic financial crisis.”

If he is right, it is all the more important that ways be found
to assure that the costs of the next financial crisis —
in failed institutions and lost economic growth,
not to mention government borrowing —
will be far lower.
It is hard to conclude much progress has been made in accomplishing that goal.

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