Arnold Kling  

Bank Strategy: Nothing New?

Up in the Valley... What Would Keynes Do?...

The Wall Street Journal quotes a joint statement by U.S. bank regulators.

The U.S. government stands firmly behind the banking system during this period of financial strain to ensure it will be able to perform its key function of providing credit to households and businesses. The government will ensure that banks have the capital and liquidity they need to provide the credit necessary to restore economic growth. Moreover, we reiterate our determination to preserve the viability of systemically important financial institutions so that they are able to meet their commitments.

I read this as a continuation of the policy of propping up zombie banks. My instinct is that it will extend the crisis and put large amounts of taxpayer funds at risk.

It seems as though our government has an unlimited supply of charity to offer speculative homebuyers and overly-aggressive banks. I personally resent paying for my share of that charity. And I do not think that the positive externalities from that charity are nearly large enough to justify calling it a public good.

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COMMENTS (7 to date)
ionides writes:

Monty Python had a sketch where an apartment buidling was about to collapse because people lost confidence in it. I think that was a metaphor for the banking system.

Does the financial system have to be this precarious? Would a 100 percent reserve requirement eliminate this kind of vulnerability?

hacs writes:

It is not charity but the rule of the law.

These days show us that the market does not follow even the market laws (as Mr. Greenspan believed - maybe, because some of the irrational voters that you mentioned some months ago manage a business), so, it needs synthetic laws (what, how much, etc., are the important questions).

By means of the faith in it, uniquely, will not grace us.

Joe writes:

100% reserves would be just as susceptible to regulatory arbitrage as an X% reserve system. Fractional reserve banking came into existence to arbitrage time differences in when depositors would want their on demand deposits. It is a market solution, which like all market solutions is human in creation, existence and operation. This makes it inherently fallible. A warehouse would work, and it would be free (a hole in the backyard, the freezer, even the mattress)

I agree with Arnold that propping up Zombie banks and their shareholders is despicable, but I disagree and believe there are far greater positive externalities, especially from a social point of view (ie destroyed families, children, and neighborhoods) for assisting home owners. Unfortunately, we will assist some who do not deserve assistance; they knowingly took substantial risks with their decisions (but I DOUBT this is a majority). But, I am less worried about homeowners defaulting than I am about supporting banks/investors whose job it is to arbitrage and manage risk in society, who basically gave people massive put options on their houses that are now being executed. If you give someone 120% the value of an asset, and then that asset price falls (Especially by 40%!!!), the option will be executed.

Art Deco writes:

Dr. Kling:

Luigi Zingales and (now Gregory Mankiw) have been promoting the idea of a debt-for-equity swap to recapitalize stressed banks. Aside from the absence of the appropriate provisions in federal banking and bankruptcy law, what impediments to doing so? Dr. Zingales has said in attempting to persuade Treasury officials to assemble such a plan, he has been put off with excuses about time constraints and Congress being in recess. Citibank has about $2,200 in nominal assets and $770 billion in deposits. There is currently in this country $750 bn in outstanding financial commercial paper. If $100 bn of that is Citibank's and they have a further $100 bn in interbank loans on their books and some $20 bn in FDIC guarranteed bonds, that amounts to 2,100-750-100-100 = 1,130. Why not a 'speed bankruptcy' for Citigroup, turning those stakeholders into equity owners? The bonds and securitized debt have a par value, the loans from divers parties have a monetary value, and there are some conventions for valuing options and derivatives that can be written into law, no? What gives?

Bill Woolsey writes:

Art Deco:

Long term bonds are the best candidates for a swap for equity.

The Snob writes:


None of us opposed to 'the bailout' are in favor of destroyed families/children/neighborhoods. If anything, we're motivated by a concern that the policies intended to avert limited misery now will lead to more widespread misery later.

For instance, it is no longer solely the domain of eccentrics to wonder about the possibility of a US sovereign debt default/crisis. This is like worrying about a house fire while a tsunami is brewing offshore. There are multiple scenarios, many less hyperbolic than a collapse in the market for US debt, that are quite a bit nastier than a few million foreclosures.

In any case, there are hundreds of thousands of foreclosures every year, even in good years, most of which do not result in divorce, suicide, or shattered childhoods. In the scale of hardships that a family can go through, having to move from a nice house/condo to a less nice house/condo is pretty tame compared to, say, cancer.

SkeeWCU writes:

The problem most of us have with the housing dilemma is the simple fact that some of this "charity" is going to people who have no business living in the abode that they do. Of course, this is exaggerated in everyday discussions, like some other forms of the stimuli our government is launching, but still makes the average citizen that pays his or her bills each month grit their teeth.

As for the banks, taking into consideration the executive spa treatment that some of the first bail out money went to, one cannot help but to speculate that more "charity" is desired not for the sake of homeowners, but for the sake of the poor, pitiful organizational leaders. This question especially arises when money is being given to these zombie banks. As said above, some of us are conscientious objectors to footing stimulus for seemingly useless motives.

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