Summary: The US and Europe have not recovered from the 2008-09 crash in part because we applied first aid, but squandered the time those measures bought for us (at great cost). An essential aspect of post-crash reforms is fixing our financial systems. The bailout of Spain’s banks — expensive for Spain’s people, easy money for the banks — illustrates the problem. Here we give details and alternatives. At the end are links for more information
Banks are central institutions in western economies. Almost every severe economic crash has a large bank failure in the early phases. That’s almost inevitable given their exposure to the broad economy, leverage, and reliance on borrowed funds. But their political power makes them resistant to reform, and full recovery from a downturn usually requires their reform. The most important aspect of this is sharing the loses. Banks will use their political strength to shift losses onto other. That’s neither fair, economically sound (as it encourages moral hazard), or necessary.
It’s another example of Capitalism Lost: America goes broke because we forgot how to be capitalists.
The US has experienced massive bank failures every decade since 1980, and we’ve yet to learn how to cope with them. This is learned helplessness, a consequence of money usefully applied to shape not only public policy but als0 public outcomes. We saw this demonstrated in the rise and corruption of the Tea Party movement. Born in opposition to bank bailouts, becoming shock troops for election of bank-friendly Republicans (for details see Occupy Wall Street, another futile peasants’ protest).
For a summary of the problem and alternative see “The Heart of the Matter“, John P. Hussman, 11 June 2012 — Excerpt:
In effect, we’re going into another recession because we never effectively addressed the problems that produced the first one, leaving us unusually vulnerable to aftershocks. Our economic malaise is the result of a whole chain of bad decisions that have distorted the financial markets in ways that make recurring crisis inevitable.
… Every major bank is funded partially by depositors, but those deposits typically represent only about 60% of the funding. The rest is debt to the bank’s own bondholders, and equity of its stockholders. When a country like Spain goes in to save a failing bank like Bankia — and does so by buying stock in the bank — the government is putting its citizens in a “first loss” position that protects the bondholders at public expense. This has been called “nationalization” because Spain now owns most of the stock, but the rescue has no element of restructuring at all. All of the bank’s liabilities – even to its own bondholders – are protected at public expense. So in order to defend bank bondholders, Spain is increasing the public debt burden of its own citizens. This approach is madness, because Spain’s citizens will ultimately suffer the consequences by eventual budget austerity or risk of government debt default.
The way to restructure a bank is to take it into receivership, write down the bad assets, wipe out the stockholders and much of the subordinated debt, and then recapitalize the remaining entity by selling it back into the private market. Depositors don’t lose a dime. While the U.S. appropriately restructured General Motors – wiping out stock, renegotiating contracts, and subjecting bondholders to haircuts – the banking system was largely untouched.
The failure of our policy makers to restructure debt resulted in the worst of both worlds – an economy where banks were relieved of the need for transparency (thanks to accounting changes by the FASB), and yet homeowners strapped with bubble-sized mortgage obligations saw very little in terms of debt restructuring. The reason we never got any economic traction in this “recovery” is that these debt burdens remain in place. While we certainly don’t advocate “freebie” principal writedowns – which would almost surely result in a tsunami of strategic defaults, we’ve long proposed what we’ve called Property Appreciation Rights as a way to partially substitute mortgage principal for a marketable claim on future appreciation. Failing any meaningful debt restructuring, however, we’ve got a financial system that continues to operate with a confident government backstop for risk taking, while aggregate demand remains suppressed by a burden of existing debt.
Tragically, nobody seems to have learned a thing from the dot-com crash, or the tech crash, or the housing crash. Wall Street continues to beg for monetary interventions to reward speculative trading, even though these rewards have repeatedly proved to be short-lived. What investors don’t seem to appreciate is how much of our nation’s scarce savings have been burned to ashes as a result.
For more information
(a) Other articles about the Spanish bank bailout:
- Spanish bank bailout unlikely to succeed, Meg Greene (Economist, Roubini Global Economics), 8 June 2012
- The Spanish ‘Bailout’, Whoops – ‘Assistance’!, Satyajit Das, Roubini Global Economics, 10 June 2012
(b) Posts about banks:
- A free lesson from Russia: how to manage a banking crisis, 6 February 2009
- The best way to rob us is to own a bank, 10 April 2010
- Former Central Bank Head Karl Otto Pöhl says bailout plan is all about ‘rescuing banks and rich Greeks’, 20 May 2010
- FDR explains one dimension of our problem: bankers own the government, 23 November 2011