February 01, 2013

We need banks to fail. What other language speaks?

The obvious problem with TBTF - too big to fail - is that banks that successfully manoeuvre governments into awarding them with the honoured right of printing money for nothing (aka bonuses, and chicks for free) also set the governments up for the eventual fall.

Although bank failure is traumatic, the alternate is far worse, at every possible level. Economic theory has it quite simply: if a bank fails, then all the directors must be punished, all the shareholders be set to zero, and the creditors must lose. No other reminder is sufficient to instill in the public's minds the need to treat their banks with skepticism.

But western, socialist or community minded governments often fall into the Misean trap of thinking they can do better than the market. And at times, they can -- central banks have successfully taken over many banks, fixed them, and returned them to the market. At a profit, even.

But the market always reasserts in time. They only thing that changes is who pays for the folly. And so comes Icesave - against who's creditors a European court has ruled:

The ruling, delivered in Luxembourg by the European Free-Trade Association Court, dealt with the collapse of Icesave, an online subsidiary of Iceland’s Landsbanki. Before the crisis Icesave had used a European “passport” to open branches abroad and collected deposits in Britain and the Netherlands with almost no oversight from regulators in those countries. One condition of its passport was that it promised that its deposits were backed by a national deposit-insurance scheme in Iceland. Yet when the bank collapsed Iceland’s deposit scheme was overwhelmed. Icelandic depositors in the bank ended up getting their money back; the British and Dutch governments both had to step in to compensate depositors in their countries.

Many observers had expected the court to rule that Iceland was obliged to stand behind its national deposit-protection plan and not to discriminate against foreign depositors. Instead the court found that Iceland was obliged only to make sure that it had a deposit-insurance scheme. The state was not required to pay out if the scheme had no money because of a banking crisis. Oddly, the court also found that Iceland had not breached an obligation not to discriminate between domestic and foreign depositors, even though it made only the domestic ones whole.

As an individual who had lost money in such a case, I would be yelling for blood. But as an economist, this is the wrong approach -- I the individual should be yelling for blood at the shareholders' meeting while the bank is still solvent, not after it is obviously dead.

The way the Economist writes the above story is common sense, and can get no better. Obviously, a national deposit-insurance only insures the nationals, or more precisely the residents. It's that word - "national" - which was curiously not extended to "community".

Obviously, such a scheme was in place. What is not clear is, in the sad event that it failed, why would one imply that there was another scheme behind it? Or why would one imply that a given "national deposit scheme" was a bottomless pit of value for tapping? A scheme has a value, right?

The SoFFin (Sonderfonds Finanzmarktstabilisierung - Special Financial Market Stabilization Funds) is a program of the German government with the purpose to stabilize and restore confidence in the financial system. .... The SoFFin may grant guarantees of up to 400bn euros and recapitalize or purchase assets for an additional 80bn euros.

Only if one can suspend any judgement as to the credibility and creditworthiness of the players, can one assume that a fund would never fail, but this is what people typically do. If Wikipedia knows the number for Germany, why don't the people?

This assumption flies in the face of evidence that is presented daily. Well, yesterday at least: Six of the big Canadian banks are now downgraded:

"Today's downgrade of the Canadian banks reflects our ongoing concerns that Canadian banks' exposure to the increasingly indebted Canadian consumer and elevated housing prices leaves them more vulnerable to unpredictable downside risks facing the Canadian economy than in the past," said Moody's vice president David Beattie.

We need more of it. Meanwhile, in not so sensible news, the Greeks have gone precisely backwards and declared war on themselves:

Any transaction in excess of 500 euros will soon only be allowed via credit or debit card or by check, according to a plan by the Finance Ministry aimed at combating tax evasion.

The ceiling for cash transactions is to be lowered from 1,500 euros today to 500 euros and could be reduced further over in the course of 2013. Ministry sources say that in the first quarter of the new year all companies and certain self-employed individuals will have to obtain the POS (point-of-sale) terminals that provide for card transactions.

The problem with this is that, although the Greek problem of taxation failure is well known, there is another larger problem: the Greek economy is dying. And this is a problem for the whole population, not just the sub-sector know as "the government".

People need to eat. If the economy is failing, they need to resort to themselves, their local communities, their families and their long standing local trade relationships. They need small trades, efficient trades, hand to hand and barter.

Trust at a local level, because there is nothing else. It is no longer a question of savings, or deposit schemes, or even taxation - it's about survival. People need the cash.

Instead of assisting this process, and serving the very survival of their People, the government of Greece is assisting the banks which everyone knows to be bankrupt. Which then is a shot across the bows of the Greek People.

So one has to ask a question - are the People of Greece irretrievably stupid? Will they rush in droves to place their cash in banks, and trust in the Greek Government to make them whole if there are any failures? Is their national deposit scheme a bottomless pit of value?

Or, are they possibly like the now chastened British and Dutch - a little more skeptical of offers endorsed by a regulator who's best idea for repairing an economy is to strip raw circulating cash out of the economy. Or, the Spanish, who are moving (their cash and sometimes themselves).

Coincidentally, stripping the cash out of the economy is an idea championed to great effect in the 1930s by none other than the USA Federal Reserve.

When banks are bankrupt, we need them to fail. What other language will get the message through?

Posted by iang at February 1, 2013 05:29 AM | TrackBack

there is discussion on TBTF playing in (closed linkedin) Financial Crime Risk, Fraud and Security ... a few of the references:

HSBC's Settlement Leaves Us In A Scary Place
Outrageous HSBC Settlement Proves the Drug War is a Joke
Neil Barofsky: Too Big to Jail -- Our Banking System's Latest Disgrace
The Punishment and the Crime; Banks Don't Go to Prison
UBS Libor Manipulation Deserves the Death Penalty
How Bankers Help Drug Traffickers and Terrorists
"Mexico's drug war undiminished in some areas
close to Texas, authorities say"
Insight: How Colombian drug traffickers used HSBC to launder money
JPMorgan Chase slammed by regulators for control failings after botched derivatives bet
Once Again, Jamie Dimon Gets Special Treatment
OCC Issues Cease and Desist Order Against JPMorgan Chase, N.A., Related to Bank Secrecy Act/Anti-Money Laundering
Professor Coffee Hits a Nerve at SEC
Has Departing SEC Enforcement Chief Robert Khuzami Become Damaged Goods?
How to Cut Megabanks Down to Size
The Dallas Fed Is Calling For The Immediate Breakup Of Large Banks
Banking Regulator Calls for End of 'Too Big to Fail'
What's Inside America's Banks?
Lanny Breuer Now Blames 94 US Attorneys for Immunizing Banksters
The Fed's Too Easy on Wall Street
Banksters used $85 billion of $140 billion taxpayer TARP money for bonuses in 2008
Yglesias Pours the Geithner, Holder, Breuer (GHB) Banksters Immunity Doctrine in our Drinks
Are Banks Too Big To Prosecute?
The Untouchables

Posted by: Lynn Wheeler at February 1, 2013 01:29 PM

one of the comments along the way was that over 700 people were convicted in the S&L crisis ... but in this latest event ... which has been significantly worse ... nobody is doing jail time.

Posted by: Lynn Wheeler at February 1, 2013 06:12 PM
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