All over Europe, bank bailouts, which never stopped from 2007 on (we just stopped talking about them so loud or re-branded them "sovereign debt bailouts"), have started accelerating again. Recent days have seen discussion or enaction of bailouts in Ireland, Spain, France, Cyprus and Greece. Today senior ministers of a number of Eurozone members are apparently set to demand an EU-wide guarantee on all deposits. If matters in the Eurozone get out of hand, there could yet be discussions of more bailouts of the big British banks.
I have opposed this bailouts strategy since it began. In my view it has been the most expensive folly since the age of the pyramids. Sometimes, though, a strategy that is a bad idea can trap policymakers – so even if they should not have started down the path, once they have begun they have no choice but to see it through to the end. That is not the case with the bailouts. They can abandon this failed and destructive scheme at any time. They could even withdraw from what has already been done, but they certainly do not have to do yet more bailouts as banks come under further pressure now.
If not yet more bailouts, what instead? Just give up and let matters take their course – laissez-faire? By no means! Here is my six-point plan for dealing with the banks.
- No recapitalisation; no government loans or guarantees of loans to bust banks; no extension of deposit guarantees beyond what is already in legislation. The strategy was immoral and destructive from the beginning. Furthermore, a number of states simply cannot afford to bail out their banks. Recent days have seen the absurd suggestion that Spain should bail out its banks and then, because that would bankrupt the Spanish state, Spain should appeal to the Eurozone for financial assistance. Bailing out its banks risks leaving Spain in the same situation Ireland found itself a couple of years ago, in which an essentially solvent sovereign bankrupts itself entirely gratuitously to spare those that foolishly lent money to bust banks from the fruits of their folly. The bailouts are the main reason Greece is likely to leave the euro. Their further extension would risk causing the total distintegration of the euro. This wicked and destructive folly must end, before it drags even prudent peoples, strong economies and noble projects into its web of misery.
- Suspend formulaic capital adequacy ratio requirements. Rules saying banks must hold this or that percentage of capital are intended to limit the risk that financial crises occur. Once financial crises are in play, such rules are at best irrelevant (for markets may require higher ratios) and at worst highly counter-productive. There are two key ways they can be counterproductive. First, they can put institutions that would survive market turmoil into unnecessary regulatorily-induced distress. Second, they can drive the system as a whole to deleverage even faster than the market requires, causing money supply growth to collapse, inducing deflationary debt spirals. Regulatory capital adequacy assessments, under these conditions, need to be entirely bespoke and conducted by central banks in intimate and ongoing relationship with the institutions they regulate.
- Depositor liquidity insurance. Depositors do not run on banks because they have a rational fear of losing their money. Typical recovery rates for depositors, even in epic insolvencies such as the US bank runs of the 1930s, are in excess of 80 per cent. Depositors run on banks because they fear losing access to their money. Deposit guarantees only "work" in the sense that the larger they are, the more likely depositors believe it to be that governments will bail banks out (and evidence suggests they are right to believe that). What needs to be guaranteed is that depositors (including small and medium-sized business depositors) can continue to use their funds. There are two key elements to that. First, governments must stand willing to take control of payments systems (through special administration procedures similar to those applying to water, electricity, airports and so on), so that ATMs, credit cards in shops, and the like keep working. Second, governments should allow depositors to withdraw up to 80 per cent of their deposits, as normal, but formally these would be loans from the government. (I suggest the creation of a Deposit Access Fund, paid for out of newly printed money. Liquidated asset monies would simply be returned to the Deposit Access Fund, to be withdrawn from circulation in due course.) In the event that liquidation of banks did not yield enough money to cover monies withdrawn, the relevant depositors would owe the government a tax liability, to be recovered through PAYE systems.
- Depositor preference. If banks are liquidated, depositors should rank ahead of bondholders.
- Debt-equity swaps. If banks have significantly inadequate capital or are insolvent but viable trading entities, they should fall into the hands of their bondholders – just as any other business falls into the hands of its creditors if it goes bust. That means the bondholders should own it – their debts should be converted into equity stakes in the bank. That would recapitalise almost all banks without government recapitalisation schemes or liquidation. The Basel Committee, the European Commission, and the UK government all agree that debt-equity swaps are how the authorities should response to future banking crises. If that's the way to do it next time (and it is), why not do it that way this time?
- Solvent institutions should be lent monies by the central bank. Central bank provision of liquidity to solvent institutions, at a penal rate, is not a bailout. It is what central banks exist for in a fractional reserve banking system.
Over the longer-term there are many other regulatory changes required in the banking sector, which I have discussed many times before. But the above six-point plan constitutes a realistic and viable alternative to more bailouts. This is the direction we should go.