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We are now a giant step closer to debunking the myth of 'too big to fail’

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In future crises the Bank of England will have the power to sack bank bosses - Image: Getty Images


We are now a giant step closer to debunking the myth of 'too big to fail’


It should no be possible to resolve any large UK-based institution without needing a taxpayer bailout

The Telegraph
By Allister Heath
23 October 2014

Bank bail-outs have been a cultural catastrophe for those of us who support free markets, low taxes and enterprise. During the 1980s and 1990s, much of the British public came to accept and even embrace capitalism, in return for a simple deal: profits and losses would both have to be privatised. Clever entrepreneurs, savvy traders or brilliant footballers would be encouraged to make money; but companies and investors that placed the wrong bets would be allowed to fail, with no pity.

Not only did this trigger an explosion in prosperity, it also helped shift the British mindset towards a much more pro-enterprise position. The rules of the game felt fair: risk and reward went hand in hand. The government would serve as an umpire, not a supporter of vested interests.

But the crisis of 2007-09 put an end to this implicit bargain, at least in the eyes of vast swathes of the public. They saw large institutions bailed out at great public expense, and with substantial amounts of taxpayer money put at risk. It started to look as if – when it came to the banking industry at least – risk had been socialised while profits remained private. To many members of the public, it was a case of heads you win and tails we lose. Profits were retained by a small elite, while losses were spread much more broadly – or so it felt.

Needless to say, the reality was more complex. Shareholders of bailed-out banks often lost everything. But bondholders were rescued, institutions survived, staff contracts were not ripped up and the process of creative destruction was severely derailed. And while big beasts were kept afloat, many smaller firms went bust and many ordinary folk lost their jobs. This is one reason – together with an incorrect narrative of the causes of the crisis which wrongly absolves governments and central banks – for increased support for punitive tax and government meddling in prices and wages.

So why did governments turn their back on capitalism and suddenly refuse to let market forces do their work? The uncontrolled failure of a major financial institution has a much broader, system-wide impact than the uncontrolled failure of a hair salon. Under traditional bankruptcy law, however, both would be treated in the same way, which simply makes no sense. One needs a different approach to tackle the failure of major banks or insurers – a proper Plan B. With the right institutions in place, there need not be such a thing as “too big to fail”. With the correct planning and tools, even the largest of financial firms can be dismantled sensibly without wiping out millions of depositors and triggering another Great Depression.

Unfortunately, in Britain, the authorities appeared in all seriousness to hope that there would never again be a major financial crisis. There was no Plan B, no modern resolution mechanism to deal with the crisis that befell RBS, HBOS and Northern Rock. The choice was either an inappropriate bankruptcy or a bail-out.

The situation in the US was slightly better: the authorities there knew all about dealing with the failure of smallish retail banks. They had mopped up after the savings and loans crisis and the Federal Deposit Insurance Corporation (FDIC) has wound up and resolved hundreds of small banks in recent years. But where the US authorities were as hopeless as Britain’s was when it came to dealing with huge, global universal banks with complex balance sheets and vast wholesale operations spread around the globe.

When the crisis started in earnest in the US, the Fed tried to get solvent banks to take over failing ones – though this often ended up overwhelming and contaminating the good institutions. By the time the crisis had spread to Lehman Brothers, the US authorities were all over the place. They bailed out AIG, the insurance giant, but allowed Lehman to go bust in a traditional, entirely uncontrolled manner. The impact was catastrophic: markets froze and the global economy was plunged into a severe recession.

Some wrongly interpreted this as confirming that Lehman – and therefore dozens of other institutions – were too big to fail and should never be allowed to go bust. But as regulators all over the world now acknowledge, this is simply not true. They have all been working on plans for a new bankruptcy code and set of resolution mechanisms fit for global mega-banks. Britain’s resolution regime has been a work in progress since 2009; but after several attempts at progress and much global bickering, we are finally nearing a genuine breakthrough.

Supporters of free enterprise should embrace all of this: resolution mechanisms are the pro-market alternative to bail-outs. Their goal is many-fold: restore market discipline and the fear of failure; eliminate moral hazard; protect taxpayers; help depositors; and ensure that the economy is protected from any fallout.

Under proposals published by the Bank of England on Thursday, we now know much more precisely how it would step in and take control of a failing institution over a 48-hour period, usually a weekend, and how it would wind it down and transfer its assets back to the private sector as speedily as possible.

The Bank would have several options at its disposal: it could sack bosses; it could transfer all or part of a failed firm’s business to a willing private sector purchaser; it could create a temporary bridge bank to which all or part of the failed firm’s operations would be transferred to; and most promising of all, it could order a bail-in to recapitalise a failed bank without the use of taxpayers’ money. Under the latter procedure, shareholders would be wiped out and unsecured creditors would see their bonds converted in fresh equity to restore solvency. Crucial to all of this are transparency and living wills: banks need to structure themselves in such a way that it can be resolved and dismantled speedily.

In theory, with the tools now at the Bank’s disposal and the financial system’s dramatically improved capital position, it ought to be possible to resolve any large UK-based institution without needing a taxpayer bailout, starting in the new year. The job of the authorities will be to make sure that the new system also works in practice - and then to communicate forcibly to a sceptical public that bail-outs and corporatism have been banished once and for all, and that financial capitalism has once again been made free and fair.

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4 comments :

  1. Not good ... sorry for that .... I do not find pleasure to see people killed ....

    The summer, thankfully, has been largely bereft of the dismal trend of bankers committing suicide, but as Bloomberg reports, Thierry Leyne, a French-Israeli banker and partner of Dominique Strauss-Kahn, the disgraced former chief of the IMF, was found dead Thursday after apparently taking his own life by jumping off the 23rd floor of one of the Yoo towers, a prestigious residential complex in Tel Aviv. This is the 16th financial services executive death this year.

    ;;;;;;
    Wonder when politics will start 'jumping' through windows ....

    ReplyDelete
  2. Does this mean one's savings or cash in bank?

    "and most promising of all, it could order a bail-in to recapitalise a failed bank without the use of taxpayers’ money. Under the latter procedure, shareholders would be wiped out and unsecured creditors would see their bonds converted in fresh equity to restore solvency"

    If so then we need an easily researched measure of bank health. I have no idea where to start. Can anyone help with suggestions so I can do my research? Thanks.

    ReplyDelete
    Replies
    1. Pension funds, savings, safe deposit boxes...everything except for shareholder's equity...

      You can start by "Google" ing terms..."US bank's stress test results" or" insolvent banks" or " most solvent banks"

      Delete

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