I am not an American so this does not concern me directly, yet I very much sympathize with your outrage. I think getting angry at bailouts is a necessary first step, but won't fix the problem. It's a systemic problem: the law treats deposits as risk-bearing loans, yet the public mostly believes deposits ought to be risk-free. Politicians…
I am not an American so this does not concern me directly, yet I very much sympathize with your outrage.
I think getting angry at bailouts is a necessary first step, but won't fix the problem. It's a systemic problem: the law treats deposits as risk-bearing loans, yet the public mostly believes deposits ought to be risk-free. Politicians, therefore, will always cave to pressure to bail out depositors. Also, bailouts are an "easy fix" for the systemic crisis risk (with very bad long-term incentive implications).
Professor John Cochrane has long ago outlined a systemic solution, and we should be shouting that this is what we want so that people stop accepting bailouts as a necessary evil.
Here's my inaccurate summary:
1. banks would be financed strictly by equity, would shoulder no bank-run risk.
2. bank deposits would be replaced with money market funds, that would be instantly convertible to cash.
3. if banks absolutely need to be credit-financed (equity is too expensive), let them get it through the intermediation of bank holding companies, which would issue equity and debt and buy bank equity.
implications:
- the banks themselves would never have to face a run. No need for a labyrinth of risk regulation. The bank's risk-taking can be regulated by its shareholders because the public is not on the hook.
- no more moral hazard, bail-outs are not necessary
- savers bear some risk of bank failure (more than now because there are no more bailouts), but now the risk is gradually and explicitly reflected in the price fluctuations of the money-market funds in their accounts.
Hoping that depositors would be competent bank risk analysts might not be a good plan. It does not seem to work politically, because the public rejects this assignment of responsibility and keeps giving depositors a free pass.
Cochrane's motivation, by the way, is preventing GFC-style systemic crisis. Avoiding both the pressure for bailouts and the heavy regulatory investment-risk-police are (very nice) side-benefits.
I am not an American so this does not concern me directly, yet I very much sympathize with your outrage.
I think getting angry at bailouts is a necessary first step, but won't fix the problem. It's a systemic problem: the law treats deposits as risk-bearing loans, yet the public mostly believes deposits ought to be risk-free. Politicians, therefore, will always cave to pressure to bail out depositors. Also, bailouts are an "easy fix" for the systemic crisis risk (with very bad long-term incentive implications).
Professor John Cochrane has long ago outlined a systemic solution, and we should be shouting that this is what we want so that people stop accepting bailouts as a necessary evil.
Here's my inaccurate summary:
1. banks would be financed strictly by equity, would shoulder no bank-run risk.
2. bank deposits would be replaced with money market funds, that would be instantly convertible to cash.
3. if banks absolutely need to be credit-financed (equity is too expensive), let them get it through the intermediation of bank holding companies, which would issue equity and debt and buy bank equity.
implications:
- the banks themselves would never have to face a run. No need for a labyrinth of risk regulation. The bank's risk-taking can be regulated by its shareholders because the public is not on the hook.
- no more moral hazard, bail-outs are not necessary
- savers bear some risk of bank failure (more than now because there are no more bailouts), but now the risk is gradually and explicitly reflected in the price fluctuations of the money-market funds in their accounts.
Hoping that depositors would be competent bank risk analysts might not be a good plan. It does not seem to work politically, because the public rejects this assignment of responsibility and keeps giving depositors a free pass.
Cochrane's motivation, by the way, is preventing GFC-style systemic crisis. Avoiding both the pressure for bailouts and the heavy regulatory investment-risk-police are (very nice) side-benefits.
https://johnhcochrane.blogspot.com/2016/05/equity-financed-banking.html