Arnold Kling  

Cap Creditors' Bailouts?

Marginal Tax Rates, Again... Unchecked and Unbalanced

Russ Roberts tucks an interesting suggestion into his diatribe against the arrogance of financial regulators.

A ceiling of 50 cents on the dollar for creditors and lenders when the institutions they fund become insolvent is a natural place to start

Suppose that we could somehow decree that, apart from individual depositors, creditors and lenders could receive no more than 50 cents on the dollar in any resolution of a financial firm that requires taxpayer support. If that were an ironclad rule, then creditors would have an incentive to force insolvent financial firms into bankruptcy. That in turn might induce creditors to write bond covenants that require the sort of "living wills" that regulators are starting to consider. It might even induce creditors to stay away from large, complex, opaque financial institutions and put their money instead in smaller, more straightforward banks.

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COMMENTS (6 to date)
wm13 writes:

What is the harm sought to be prevented by this proposal? Excessive interbank lending? And how does a single university professor know that 50% is the proper number to produce the optimal amount of interbank lending? Could it be 60% or 40%?

scott clark writes:

The harm sought to be prevented is the harm done to incentives for risk taking and prudence in financial markets caused by the implicit promise, now made more explicit, of bailouts for well connected firms.
Roberts says the optimal is a zero bailout promise but in a world where that is not a credible promise, can we please try something like half.
Roberts never claims to know the optimal amount of interbank lending, but he does know, and I think he is right, that if creditors are banking on a govt bailout to cover their downside risks, we are pretty far away from anything that can be called optimal.

[Comment edited to remove crude acronymn.--Econlib Ed.]

wm13 writes:

I don't have access to the article, not being an academic. In any case, there is no need to swear at me.

[wm13: The crude language has been removed. Though it wasn't directed at you personally, it was inappropriate. We apologize for the problem.--Econlib Ed.]

scott clark writes:

You can sign in as a guest, that's what I did

and I was only kinda swearing, kinda using the standard internets lingo

Ryan Vann writes:

This would be a pretty pragmatic step (in a legislative sense) in reversing the moral hazard caused by implicit protection, as well as GSE's.

Politically, the powerful financial firms still get some level of risk buffering from Uncle Sam, but the pitchfork wielding mainstreeters are somewhat appeased. That isn't to say there wouldn't be lobbying against this, but that lobbying wouldn't have much ground to stand on.

Steve writes:

To wm13 - you can get Russ' article. I registered under the "University of Continuing Education". It has a faculty of one - me.

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