The credit crunch, bailouts, and moral hazard


in Canada, Economics, Geek stuff, Law, Politics, Rants

Why did governments bail out failing financial institutions?

They said it was because banks and insurance companies were so interconnected with the rest of the economy that, if they failed, they would cause a cascade of other failures. If the banks went broke, firms that actually have sound businesses would fall as well. That supposedly risked turning the credit crunch into a general depression.

Assuming this argument is correct, the natural question is what we should do to eliminate that vulnerability, termed ‘systemic risk’ by economists. It is as though we are mountain climbers attached by a tether to the banks. When they start to slip, we need to save them, in order to keep from being pulled over ourselves. Once we have done that, however, we need to start thinking about how to get rid of tether.

According to the argument that politicians are making, we got dragged to the edge of the cliff this time. To experience that and not think seriously about how to get ourselves untethered is stupid and irresponsible.

1) Make banks smaller

No single bank should be large enough that its collapse could threaten the economy as a whole. Banks should be small enough to fail.

2) Make finance more boring

Get rid of complex new products like collateralized debt obligations and credit default swaps. Treat new financial products like new pharmaceuticals, with the onus on those developing them to show that they are safe, and with tough oversight and regulation.

These things seem to spread risk around in the financial system in ways that make it possible for relatively minor players (even non-banks) to really screw things up.

3) Separate the safe and risky sides of banking

There should be two sorts of banks.

The first sort will take deposits and make very safe loans, like well-secured mortgages or loans to businesses with a strong plan for paying them back. These banks should be insured, so that if they fail the depositors don’t lose their money.

These banks should be allowed to call themselves ‘safe banks’ or ‘guaranteed banks’ or something similar, so it is clear to everybody that they are in a special category that excludes the second type.

The second sort can basically do whatever they like. They can invest in all sorts of unusual financial instruments, and try to make profits. When they fail, their depositors get nothing. The only things they cannot do are get too big (see point 1) or sell products that threaten the system (see point 2).

The government loves to boast about how well Canada weathered the financial crisis. The basic reason for that seems to be how boring our banks were forced to remain, as the result of heavy regulation. The places with laissez faire regulatory approaches – like the United States, Ireland, and Iceland – are the ones that have had the most to fear from the credit crunch.

4) Accept the drawbacks

This plan has a number of drawbacks.

First, it might make the financial system less efficient at allocating capital. That’s what banks claim is their value added to society: they match up people who have wealth but no ideas for using it productively with people with ideas and talents, but not enough money.

Making the financial industry safer would reduce returns for savers, and reduce the financing opportunities for firms and entrepreneurs. We might be turning a Ferrari into a Volkswagen, but there are good reasons to do so. For one, it is better to ride in a Volkswagen at 90 km/h than in a Ferrari that goes 120 km/h but sometimes explodes and kills everyone inside. For another, banks and bankers will always have the financial means to manipulate politicians. They are well placed to get a good deal for themselves, whereas the general public is in a weaker position. Since there is a built-in bias in politics towards making things easier for the rich, having some special protection for the general welfare of the population seems justified and appropriate.

Second, making the system safer will make it harder for poor people to get credit. The safe banks won’t offer mortgages to people who are likely to default on them, and the risky banks are likely to change an arm and a leg for them. That said, it was probably always a fantasy for people of modest means to buy big houses in cities with overpriced property markets. Also, by reducing the speculative froth in real estate markets, the approach outlined here could end up helping such people in the long run.

That being said, I think a plan basically resembling this one is worthwhile. Most importantly, it would largely eliminate the systemic risk which we are creating right now by bailing out the institutions that have been the least responsible, because of the threat they pose to everyone else. What that approach will ultimately produce is another, larger crisis.

Of course, this is all a pipe dream. Politicians don’t have the bravery or far-sightedness to do any of this, and bankers are clever enough and rich enough to convince them and bribe them into leaving them basically alone. Besides, that next crisis will probably happen when another lots of politicians are in charge, and those who organized today’s bailouts are occupying well-paid seats on the boards of the banks they rescued.

{ 38 comments… read them below or add one }

Byron Smith May 28, 2010 at 8:51 am

I’m totally with you on this. Good post.

They said it was because banks and insurance companies were so interconnected with the rest of the economy that, if they failed, they would cause a cascade of other failures.
This made me think about the other things that are so interconnected to the rest of the economy that if they failed would cause a cascade of failures. Like, stable climate, fresh water access, arable soil, living oceans, and so on. There is an ecological credit crunch that governments are largley ignoring, not because it is smaller, but because it is bigger and more difficult to bail out.

Milan May 28, 2010 at 9:55 am

The way I see it, dealing with the credit crunch has been a massive distraction from working on things that are ultimately much more important – foremost among them, preventing catastrophic climate change.

Given that we’ve had to commit all this time, money, and political capital, we should at least be working to change the system so that we won’t need to do this all over again in the next few years.

Of course, it is much easier politically to just do the bailout and return to business-as-usual. The strangest element of that is probably populist opposition towards further bank regulations. That seems like a classic example of people being tricked into providing political support for something that is ultimately not in their interest.

Tristan May 28, 2010 at 10:07 am

I think it’s essential to look at this problem historically. Prior to the 1970s, the financial “tools” which allow the pricing of commodities to difficult for humans to understand was not possible. The financialization of the economy had two major (and related) aspects – de-regulation, and technological innovation. Technological innovation allowed trading to occur at speeds incomprehensible, and de-regulation allowed the trading of entities which previously were not allowed to be traded.

Byron Smith May 28, 2010 at 10:09 am

Precisely. People are more suspicious of governments charged with restraining wickedness than they are of corporations charged with making money. Both can make terrible mistakes (if nothing else, power means the ability to multiply the effects of your mistakes), but I know where my greater suspicions are directed. This is oversimplifying of course.

. May 28, 2010 at 10:19 am

Canada’s economy

SIR – You appropriately recognised the benefits of Canada’s approach to regulating banks (“The charms of Canada”, May 8th). However, in the past, Stephen Harper, the prime minister, has been a vocal proponent of bank mergers and deregulation. Instead of stimulating the economy he at first celebrated the recession as a “buying opportunity”.

Threatened by the opposition-dominated Parliament, economic stimulus was a deathbed conversion for him. His present opposition to proposed financial reforms, such as bank levies and tariffs on financial transactions, needs to be understood in the context of his previous enthusiasm for bank mergers and deregulation. Leaders of the G8 and G20 should look to Canada for best practices on banking regulations, but don’t take its prime minister’s advice on the economy. To be clear: Canada’s economy is stronger than that of other wealthy countries despite Mr Harper, not because of him.

Paul Dewar, MP
New Democrat spokesperson on foreign affairs

Byron Smith May 28, 2010 at 10:28 am

To clarify, my “precisely” was in response to Milan’s comments. Tristan’s hadn’t appeared yet, though I also agree with them too.

Anon May 28, 2010 at 10:34 am

Stephen Harper, the prime minister, has been a vocal proponent of bank mergers and deregulation.

It is certainly a bit rich when politicians take credit for things they had previously worked to eliminate.

XUP May 28, 2010 at 10:36 am

I don’t really understand how the economy works on a national or global level, but you state as a drawback:

“Second, making the system safer will make it harder for poor people to get credit. The safe banks won’t offer mortgages to people who are likely to default on them, and the risky banks are likely to change an arm and a leg for them. ”

As you imply, this isn’t really a drawback at all. From what I read the majority of Canadians and Americans are very deeply in debt – encouraged by low interest rates and easily available credit/mortgages/loans and that they are not going to be able to maintain this level of debt for too much longer. There seems to be a real concern about what’s going to happen when, at some point, these debts need to be cleared.

So, I think it would be a very wise thing if credit and mortgages were more difficult to get. I once checked with my bank to see what sort of mortgage they would approve for me and the figure was ridiculous. There would be no way I would have been able to make the monthly payments on my fancy new house.

(Oh and Paul Dewar — cool!)

Milan May 28, 2010 at 10:38 am

It is certainly a bit rich when politicians take credit for things they had previously worked to eliminate.

Or even use the results of the thing they sought to eliminate in order to justify its elimination:

“Canada’s banks have held up great during the financial crisis. That means there is no problem with further consolidation and deregulation.”

Put another way:

“Ours is the only town along the river that didn’t get flooded, proving that my plan to lower and weaken the levies is sound and justified.”

. May 28, 2010 at 11:40 am

Seeking influence

SIR – Schumpeter criticised the “corruption eruption” in business (May 1st), but I wonder if we really are on such moral high ground. In foreign countries, businesses pay bribes; in America they contribute to political campaign funds. That could be a distinction without a difference.

Robert Kennedy
Seneca, South Carolina

. May 28, 2010 at 11:57 am

Complex derivatives are “intractable” — you can’t tell if they’re being tampered with


“Computational Complexity and Information Asymmetry in Financial Products,” a new paper by Princeton computer scientists and economists Sanjeev Arora, Boaz Barak, Markus Brunnermeier, and Rong Ge suggests that complex financial derivatives are computationally intractable: that is, once you have mixed together a bunch of weird-ass securities and derivatives, you literally can’t tell if the resulting security is being tampered with as it pays off (or doesn’t).

Tristan May 28, 2010 at 1:26 pm

Hopefully, proper recognition of the disaster which is monetary and financial policy since the 1970s motivates a shift to a rational regulation of non-governmental actors, and an end to the dogma that only bankers can understand banking, and that therefore monetary policy must be kept out of publicly accountable politiciens’ hands.

The proper solution to the massively increased debt is measures of debt-forgiveness, linked to the coming decline in property values.

. July 16, 2010 at 8:46 am

“Inspired by Mr Delors, some in Europe now grappling with the fate of the euro argue that crises always lead to a leap in EU integration. Championed by France, they argue that the chaos that has spread from Greece to southern Europe shows the euro zone needs a core of dirigiste powers to run Europe in a more political and less technocratic way. To limit “unfair” competition, they want things like Europe-wide labour standards and some harmonisation of taxes. They want to oversee transfers of communal cash to the euro’s weakest members.

Yet the appetite for this sort of integration is not shared in other countries—not even in Germany which, mindful of its own history, does not trust politicians with monetary policy. Its people were assured that the euro would be run with the same discipline as their beloved Deutschmark and they are sick of paying for all of Europe’s new schemes. Instead Germany wants a harsh system of rules, enshrined by treaty if need be, that would ban countries from spending too much.

If the French idea is unacceptable, the German idea is unworkable. Politics has tended to trump economics right from the start of the euro, when indebted countries like Belgium and Italy were allowed in. You cannot simply decree that every one of 16 countries in the euro zone will always behave responsibly. Someone will break the rules and, as often as not, someone else will have reason to connive with them.”

. July 16, 2010 at 11:08 am

Too Big To Fail, the 1912 Version
How Wilson and Roosevelt tried to roll back the power of corporations.
By David Greenberg
Posted Thursday, July 15, 2010, at 1:35 PM ET

In the historic election of 1912, a sitting president faced a former president and a future president. William Howard Taft, the conservative Republican incumbent, enjoyed support from banking and business, which mostly opposed any new federal powers and agencies that might restrict their freedom. The former president was Theodore Roosevelt, who, like many Democrats today, argued for coming to terms with the realities of a new economy dominated by huge corporations and using government to control them firmly. The future president was Woodrow Wilson—the eventual winner—who, insisting T.R. didn’t go far enough, assailed bigness itself, somewhat like those on the left who now despair that the package of regulatory fixes heading for President Obama’s signature won’t solve our financial problems or tame the powerhouses deemed too big to fail.

If our era, with its opulence and extravagant wealth masking inequality and hardship, deserves to be called the new Gilded Age, then our debates over financial reform have a rough historical precedent in the Progressive Era disputes on display in 1912. That year, Taft, who had come to the White House as Roosevelt’s hand-picked successor, had fallen from favor with progressives and was beaten in the Republican primaries by T.R. himself. But Taft controlled the convention, which predictably renominated him, and Roosevelt formed his own Progressive Party, with his own platform. Relying on the 1909 treatise The Promise of American Life by journalist Herbert Croly, which T.R. had been using in speeches for two years, he called it “the New Nationalism.”

Roosevelt, despite imposing historic regulations during his own two presidential terms, and despite his (somewhat inflated) reputation as a “trust buster,” had no wish to return to a laissez-faire economy. On the contrary, the New Nationalism made explicit T.R.’s emerging belief that the consolidation of the economy was an inescapable feature of modernity, one whose efficiency and productivity brought real benefits. The economic transformations, however, also made it incumbent on the federal government to actively check the trusts’ abuses and counterbalance their power. Building on the “Square Deal” rhetoric of his presidency, Roosevelt further insisted that the federal government alone should ensure the welfare of workers, farmers, consumers, and others who, through no fault of their own, hadn’t partaken in the fruits of this mighty new economy.

. August 27, 2010 at 3:47 am

Europe’s Banking Crisis: Latvia’s Third Option
Neither Devaluation nor Austerity, but Tax Restructuring

by Prof. Michael Hudson

“Sovereign governments of course can re-denominate all debts in domestic currency by abolishing the “foreign currency” clause, much as President Roosevelt abolished the “gold clause” in U.S. bank contracts in 1933. This would pass the bad-loan problem on to the Swedish, Austrian and other foreign banks that have made the loans now going bad. But most government leaders find currency devaluation so unthinkable that, at first glance, there seems to be only one alternative: an austerity program of fiscal cutbacks.”

. September 13, 2010 at 10:21 am

But cast your mind back to late 2008. Then, the share prices of the world’s biggest banks could halve in minutes. Reasonable people thought that many firms were hiding severe losses. Anyone exposed to them, from speculators to churchgoing custodians of widows’ pensions, tried to yank their cash out, causing a run that threatened another Great Depression. Now, imagine being sat not in the observer’s armchair but in the regulator’s hot seat and faced with such a crisis again. Can anyone honestly say that they would let a big bank go down?

And yet, somehow, that choice is what the people redesigning the rules of finance must try to make possible. The easier part of their job is to make the dilemma less likely, by boosting banks’ safety buffers. Here, they have done a good job of resisting the banking lobby and demonstrating that if put in place gradually, higher capital levels will only dent the economy a little now, and boost it in the long term. The final rules are due in November and will probably call for banks in normal times to carry core capital of at least 10% of risk-adjusted assets. This would be enough to absorb the losses most banks made during 2007-09 with a decent margin for error.

But that still leaves the outlier banks that in the last crisis, as in most others, lost two to three times more than the average firm. No reasonable safety buffer is big enough for them (a core capital ratio of some 20% would be required). Worse, the crisis has shown that if they are not rescued they can topple the entire system. That is why swaggering talk of letting them burn next time is empty. Instead a way needs to be found to impose losses on their creditors without causing a wider panic—the financial equivalent of squaring a circle.

. September 13, 2010 at 10:36 am

Small enough to fail
The sorry end to a bold banking experiment

Aug 26th 2010 | New York

“LET’S change the world”: ShoreBank’s slogan shouted that the Chicago-based lender saw itself as not just a bank but the leader of a movement. Founded in 1973, it set out to prove that money could be lent profitably to poor people in poor neighbourhoods. For 35 years it thrived but the financial storm that hit in 2008, and the economic downturn that followed, proved its undoing. On August 20th the Federal Deposit Insurance Corporation (FDIC), the bank’s regulator, called time on its experiment in what became known as community-development finance.

Like many financial institutions, ShoreBank was hit hard by America’s housing bust. Yet in the first few months after the house-price bubble burst, Ron Grzywinski, a founder of the bank, was able to contrast the low default rates on ShoreBank’s mortgages with the higher ones of less responsible subprime lenders, such as Countrywide. The difference, he argued, was that ShoreBank did it the “old-fashioned way”—getting to know the borrower and securing a significant down payment against a realistically-valued property.

According to someone close to the fund-raising operation, the government had indicated that if $125m of private money were raised, as it was, $75m of TARP money would be forthcoming, and that would be enough to keep ShoreBank alive. However, he says, criticism from some Republican politicians and like-minded media pundits seems to have “made the Obama administration afraid that it would be accused of favouring a Chicago institution; had it been from New York or Houston, it would have been saved.”

. September 26, 2010 at 7:19 pm

“But it is the banks that matter most; and, in banking, it is remarkable how little has changed. Many banks are still “too big to fail” and the casino side of their activities remains mixed up with the mundane business of deposit-taking. Bankers are once more earning huge bonuses. How could this be?

Breaking up the banks might have satisfied taxpayers’ desire for revenge, but it is not clear what problems it would have solved. Anglo Irish Bank and Northern Rock collapsed not because they were too big, nor because they were playing the markets: they were classic “narrow” banks which failed in the traditional fashion—borrowing short to lend long against property that turned out to be overvalued. The problems of the Spanish cajas show that a financial system with lots of small banks is not necessarily safer.”

. October 25, 2010 at 9:39 am

TARP Investment Earned Taxpayers 8.2% in Two Years

The TARP bailout of financial firms has yielded a return of 8.2% in two years.

This return, $25.2 billion on an investment of $309 billion, beats what could have been gained by U.S. Treasuries, high-yield savings accounts and certificates of deposit, Bloomberg News reported.

Sponsored Links
When it was first announced, the TARP program was expected to cost the taxpayer billions of dollars. It is still expected to make a loss overall, but the money ploughed into the banks and insurance companies has been unexpectedly profitable.

“From the perspective of the taxpayers getting their money back, TARP has been a great success,” Todd Petzel, chief investment officer at New York-based Offit Capital Advisors LLC told Bloomberg News.

. December 5, 2010 at 4:40 pm

The history of finance
The man who stamped the crash
How Ferdinand Pecora won the blame game

Nov 11th 2010 | from PRINT EDITION

The Hellhound of Wall Street: How Ferdinand Pecora’s Investigation of the Great Crash Forever Changed American Finance. By Michael Perino. Penguin Press; 352 pages; $27.95. Buy from

FINANCIAL crises have many causes and multiple actors. Sometimes, though, a single, electrifying interpretation emerges to capture the public imagination and dominate the political response. It has yet to happen with the current crisis. But for the Depression it struck dramatically over a mere ten days in early 1933, just before Franklin Roosevelt took office.

In the years after the 1929 crash, Wall Street, except for a few scoundrels, had largely escaped broad condemnation, portraying itself guilty of nothing more than the same irrational exuberance that had seized ordinary investors. In his entertaining new book, “The Hellhound of Wall Street”, Michael Perino recounts how Ferdinand Pecora, the tenacious and theatrical chief counsel to the Senate Committee on Banking and Currency, altered that impression. By the time Pecora was finished, the public saw Wall Street’s finest not as bystanders but as malicious purveyors of the misfortune that had affected millions. His campaign turned the political tide decisively against Wall Street, paving the way for the Glass-Steagall act, which split commercial from investment banking, and the Securities Exchange Act, which created the Securities and Exchange Commission.

. December 30, 2010 at 3:44 pm

Hands off our pensions
A tempting target for impoverished governments

IN THE war on savers a new front has been opened. Savers are already penalised by record low interest rates, as central banks try to bail out debtors. Now governments are feasting their greedy eyes on private-sector pension pots.

Hungary provides the latest example. A reform in 1998 created a mandatory supplementary pension system, with contributions deducted from wages and invested in a private fund. These funds have since accumulated nearly $14 billion of assets. Those assets (and the employee contributions) are now in effect being taken back by the government, since those who opt to remain in the private sector will face stiff penalties.

As Peter Attard Montalto, an analyst at Nomura, an investment bank, points out, the Hungarian government will gain in three ways from this shift. First, it will no longer have to pay contributions into the private-sector fund; the public pension scheme operates on a pay-as-you-go basis. Second, it gets the direct benefit of employee contributions, helping to reduce the budget deficit. Third, some of the private pension assets are being invested in government bonds; these can be “retired”, reducing the government’s debt. The remaining assets will be sold over the next two to three years.

. January 31, 2011 at 7:28 pm

For much of its almost century-long life, writes Mr Whalen, the Fed has served the White House and the big banks before serving the people—for instance, by repeatedly providing liquidity to stabilise financial markets under the guise of protecting the real economy. Under Alan Greenspan, the central bank encouraged and facilitated greater use of debt throughout the economy. Today’s anti-Fed movement is no flash in the pan: antipathy towards central banking stretches back to the civil-war era.

. February 2, 2011 at 9:21 pm

Jim Chanos, a hedge-fund manager who made his first fortune betting that Enron was overvalued, warned the G8 finance ministers in April 2007 that banks and insurance firms were heading for trouble. He made another fortune when bank shares crashed, but is still furious that his warnings were politely ignored. He thinks it an outrage that several senior regulators from that period are still in positions of power. And he accuses some bankers of “a wholesale looting of the system” by paying themselves bonuses based on what they must have known were phantom profits. He thinks they should be prosecuted.

. February 14, 2011 at 10:06 pm

The official verdict
America’s FCIC report is big, surprisingly readable and a disappointment

THE financial crisis may end up being worse for forests than for banks. As well as all the articles and books on the topic, there is a rising number of official reports documenting how and why things went so badly wrong. Like biographies, the authorised versions of history are less fun to read than their unauthorised versions. But dryness can easily be forgiven if access to sources and careful research produces a definitive account.

The report of the Financial Crisis Inquiry Commission (FCIC), America’s official probe, gets things slightly the wrong way round. It is breezily written, despite its bulk. “The fault lies not in the stars, but in us” is its way of underlining that the crisis was avoidable. The risk of lots of simultaneous defaults is compared to mould creeping through a loaf of bread.

In its way, the report is comprehensive. It covers everything from the complexities of securitisation and the gradual deregulation of Wall Street to the panics around the failures of Bear Stearns and Lehman Brothers. Obscure but vulnerable bits of the financial system, like the $2.8 trillion tri-party repo market, are rightly pulled from the shadows. It paints a picture of widespread mortgage fraud: one disabled borrower in his 80s was described on his loan form as being in light construction.

. February 20, 2011 at 1:07 am

The UK Bureau for Investigative Journalism has released a study that shows that more than half of the Conservative party’s financing comes from rich bankers. Top donors met one-on-one with prime minister David Cameron and other Tory leaders. One major donor was made Tory treasurer, another was given a peerage.

. July 3, 2011 at 10:51 am

America’s bail-out maths
Hard-nosed socialists
America’s loathed TARP may turn a profit. That could be a problem

Jun 9th 2011 | Washington, dc | from the print edition

THE federal government is bowing out as America’s most hated fund manager. On June 3rd the Treasury reached an agreement to sell the rest of its holdings in Chrysler, a carmaker, to Italy’s Fiat. Ten days earlier it began to sell its stake in American International Group (AIG) through a public offering of the insurer’s shares. General Motors has returned to the stockmarket (the government still owns 26% of it) and Ally Financial, a former financing arm of GM and Chrysler, will soon follow. In March the Federal Reserve began selling mortgage-backed bonds it inherited from AIG.

Nobody liked the bail-outs, not even the rescued. Tim Geithner, who oversaw them first at the New York Federal Reserve and now as treasury secretary, this week quipped to bankers: “I’m glad to not have as much equity in all of you as a group anymore.” “So are we,” one shot back. The public was the most outraged, yet on a narrow reckoning of profit and loss, taxpayers have little cause for complaint.

When Congress held its nose in 2008 and approved the Troubled Assets Relief Programme (TARP) to spend up to $700 billion to alleviate panic, the White House reckoned it might end up losing half of that amount. In the end $411 billion was ploughed into financial firms, carmakers and schemes to reduce foreclosures and restart private lending. As of June 7th $308 billion of that had been paid back. The Treasury values the remainder at $130 billion but could quite plausibly garner more. In that case it will turn a cash profit on TARP, although the picture would be worse if the Treasury’s subsidised lending rates are also counted as a cost.

. July 30, 2011 at 10:57 am

So when the financial crisis struck in the summer of 2007, bank staff with an understanding of the unfolding calamity were scarce. This helps explain why the bank’s initial response was flat-footed. While the Federal Reserve and European Central Bank found ways to flood their parched banking systems with liquidity, Sir Mervyn was lecturing on the dangers of moral hazard. The bank was forced to reverse course as the crisis intensified. Some of his antipathy to banks might be traced to this time, when his job seemed at risk.

. January 4, 2012 at 7:31 pm

Bring Back Boring Banks

Relying on the Fed and other central banks to counter panics is dangerous brinkmanship. A lender of last resort ought not to be a first line of defense. Rather, we need to take away the reason for any depositor to fear losing money through an explicit, comprehensive government guarantee. The government stands behind all paper currency regardless of whose wallet, till or safe it sits in. Why not also make all short-term deposits, which function much like currency, the explicit liability of the government?

Guaranteeing all bank accounts would pave the way for reinstating interest-rate caps, ending the competition for fickle yield-chasers that helps set off credit booms and busts. (Banks vie with one another to attract wholesale depositors by paying higher rates, and are then impelled to take greater risks to be able to pay the higher rates.) Stringent limits on the activities of banks would be even more crucial. If people thought that losses were likely to be unbearable, guarantees would be useless.

Banks must therefore be restricted to those activities, like making traditional loans and simple hedging operations, that a regulator of average education and intelligence can monitor. If the average examiner can’t understand it, it shouldn’t be allowed. Giant banks that are mega-receptacles for hot deposits would have to cease opaque activities that regulators cannot realistically examine and that top executives cannot control.

. May 1, 2012 at 7:49 am

Did Canadian banks receive a secret bailout?

Canadians were never told the true cost of a $114-billion “secret bailout” for the country’s biggest banks during the financial crisis, says a report from the Canadian Centre for Policy Alternatives.

“We’ve had a false sense of security,” said study author and CCPA economist David MacDonald.

“Ever since the global financial crisis struck in 2008, Canadians have been subjected to a constant refrain: Canada has the ‘most sound banking system in the world,’” MacDonald writes in the report. “During the worst of the crisis — 2008 to 2010 — the official line was that Canada’s banks did not require the extraordinary bailout measures that were being offered in other countries, particularly in the U.S.

“At its peak in March 2009, support for Canadian banks reached $114-billion. To put that into perspective, that would have made up seven per cent of the Canadian economy in 2009 and was worth $3,400 for every man, woman and child in Canada.”

Anon May 1, 2012 at 7:50 am

Note – this makes the revolving door between cabinet and the corporate boards of major Canadian banks even more objectionable.

How nice to be able to transition from secretly bailing out your banking buddies to getting a huge salary and bonuses from them…

Nobody May 1, 2012 at 9:00 am

I bet those taxpayer billions paid for some fat bonuses.

. October 8, 2012 at 12:56 pm

America’s Treasury Department sold 637m of the shares it holds in American International Group, thereby reducing the government to a minority shareholder in the insurance company for the first time since its emergency bail-out in September 2008. The Treasury raised $21 billion from the sale, which together with previous share sales means that the $182 billion in public money used to rescue AIG is “now fully recovered”, with a profit to the taxpayer of $15.1 billion so far.

. April 28, 2014 at 1:59 pm

Back in 1856 one of this newspaper’s editors, Walter Bagehot, blamed crashes on what he called “blind capital”—periods when credulous cash, ignoring risk, flooded into unwise investments. Given not only the inevitability of such moments of panic but also finance’s systemic role in the economy, a government had to devise some special rules to make finance safer. Bagehot invented one: the need for central banks to rescue banks during crises. But Bagehot’s rule had a sting in the tail: the bail-out charges should be punitive. That toughness rested on the view that governments should as far as they could treat financiers like any other industry, forcing bankers and investors to take as much of the risk as possible themselves. The more the state protected the system, the more likely it was that people in it would take risks with impunity.

That danger was amply illustrated in 2007-08. Having pocketed the gains from state-underwritten risk-taking during the boom years, bankers presented the bill to taxpayers when the bubble went pop. Yet the lesson has not been learnt. Since 2008 there has been a mass of new rules, from America’s unwieldy Dodd-Frank law to transaction taxes in Europe. Some steps to boost banks’ capital and liquidity do make finance more self-reliant: America’s banks face a tough new leverage ratio (see article). But overall the urge to regulate and protect leaves an industry that depends too heavily on state support.

. October 13, 2016 at 12:11 am

Housing in America
Nightmare on Main Street
America’s housing system was at the centre of the last crisis. It has still not been properly reformed

. October 13, 2016 at 12:13 am

Housing in America
Comradely capitalism
How America accidentally nationalised its mortgage market

The trouble is that, in America, the banks are only part of the picture. There is a huge, parallel structure that exists outside the banks and which creates almost as much credit as they do: the mortgage system. In stark contrast to the banks it is very badly capitalised (see chart 2). It is also barely profitable, largely nationalised and subject to administrative control.

Like water through cracks, risk still finds a way in. Federal law is silent on loan-to-value limits for borrowers, so this is one area where risky lending is booming, with a fifth of all loans granted since 2012 having LTV ratios of 95%, meaning homeowners are underwater if house prices fall by more than 5%. Most of these sit with the FHA. One big bank admits that it is selling at face value high-risk loans to the government that it expects will make a 10-15% loss due to homeowners defaulting.

And the status quo also means that, in the event of another crash, taxpayers would be landed with a big bill. How big? Consider a spectrum of scenarios. At one end, the cumulative mortgage-system losses are 10%, the same as the actual losses in 2006-14 according to estimates by Mark Zandi of Moody’s Analytics. At the other, cumulative losses on all mortgages are assumed to be 4.4%—the level the Fed used in its stress tests of the banks in May 2016. Adjusting for the pockets of capital in the system, and the profits made by some parts of it, both of which can help absorb losses, this means that the total loss for taxpayers if another crisis strikes would be $300 billion-600 billion, or 2-4% of GDP. Most of this would fall on Fannie, Freddie and the FHA, which would need to draw money from the government to pay out on the insurance claims made by investors.

. March 12, 2017 at 2:45 pm

Slowly getting there

The British government reduced its stake in Lloyds Banking Group to below 6%, meaning that it is no longer the bank’s largest shareholder (that is now BlackRock, a titan in asset management, which holds 6.3% of the shares). The Treasury bailed out Lloyds during the financial crisis in 2008 along with Royal Bank of Scotland, in which it still holds a majority stake. The public’s remaining stake in Lloyds is expected to be sold this year.

. January 14, 2018 at 9:03 pm

TEN years ago this month, America entered the “Great Recession”. A decade on, the recession occupies a strange space in public memory. Its toll was clearly large. America suffered a cumulative loss of output estimated at nearly $4trn, and its labour markets have yet to recover fully. But the recession was far less bad than it might have been, thanks to the successful application of lessons from the Depression. Paradoxically, that success spared governments from enacting bolder reforms of the sort that might make the Great Recession the once-a-century event economists thought such calamities should be.

Good crisis response treats its symptoms; the symptoms of a disease, after all, can kill you. On that score today’s policymakers did far better than those of the 1930s. Government budgets have become a much larger share of the economy, thanks partly to the rise of the modern social safety net. Consequently, public borrowing and spending on benefits did far more to stabilise the economy than they did during the Depression. Policymakers stepped in to prevent the extraordinary collapse in prices and incomes experienced in the 1930s. They also kept banking panics from spreading, which would have amplified the pain of the downturn. Though unpopular, the decision to bail out the financial system prevented the implosion of the global economy.

That would be less troubling had the world made itself more robust to future crises after the last one. In the years after the Depression, sweeping banking and financial reforms created new regulatory institutions and placed tight constraints on financial behaviour, which made finance a very boring industry for most of the next half-century. From the 1980s to the 2000s, those restrictions were largely undone: banks were given freer rein over the activities they could engage in and products they could create. The financial crisis could not have occurred without this liberalisation. Yet in its wake, the financial sector has been treated relatively gently. Oversight and disclosure have been improved and capital-adequacy rules toughened (see previous story). But some of these rules are now being relaxed, at least in America, and the financial industry’s weight in the world economy has scarcely changed. As a share of American GDP it has actually increased somewhat since 2007.

. July 2, 2018 at 5:48 pm

IMAGINE how worrying this month’s stockmarket turbulence would have been had taxpayers been on the hook for any losses. Fortunately, the government does not guarantee shares. But there is an asset class that is also vulnerable to changes in sentiment and interest rates and which Uncle Sam does stand firmly behind: housing. In 2017, through entities such as Fannie Mae and Freddie Mac, the Treasury guaranteed 70% of all new mortgage lending. The taxpayer’s total exposure to housing is enormous, at over $6trn, or 30% of GDP, but it is hidden off the government’s balance-sheet. Reform is long overdue.

Alas, complete withdrawal is a political non-starter. Fannie and Freddie make possible the 30-year, fixed-rate, prepayable mortgages Americans have come to expect.

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