The short answer is, "No."
Conclusion, the problems of systemic risk and moral hazard remain unresolved, with banks not only too big to fail but too big to manage.
VOX
Have we solved 'too big to fail'?
Andrew G. Haldane | Executive Director, Financial Stability, Bank of England
There is a simple solution to this problem. It’s called “full reserve banking”.
ReplyDeleteUnder full reserve (e.g. as advocated by Laurence Kotlikoff) it’s virtually impossible for a bank to fail because depositors are forced to bear any losses arising from failure of the loans or investments into which their money is put.
As to depositors who want 100% safety, their money is just not invested, so there is no risk there (or possibly their money is just put into government debt, e.g. Treasuries).
Depositors won’t like that, but why on earth should taxpayers subsidise a depositor whose money is put into General Motors VIA A BANK, while not subsidising the same depositor when the latter buys shares or bonds issued by GM? That is totally illogical, and its a piece of flawed logic that full reserve disposes of.
Another way to prevent banks from becoming too big to fail is to let some of them fail.
ReplyDeleteRalph, the very simple political reason that FRB is impractical and wont be implemented is that governments will not let depositors en masse take the hit. Maybe one bank, but probably not even one big bank involving trillions. Certainly not several big banks. It would be a nuclear explosion in the center of the economy. That's why there is deposit insurance.
ReplyDeleteGovernments learned the lesson in the Great Depression. It's also why central banking was introduced in the first place.
Another way to prevent banks from becoming too big to fail is to let some of them fail.
ReplyDeleteThe govt already does hit with most banks. It's called "resolution." An exception was made for the TBTF's which was technically illegal. But the govt changed the accounting rules and extended "forbearance" to keep them afloat even though many experts held that they were clearly insolvent at the time.
The political fact is that governments will not let their financial systems collapse or even severely disrupt "confidence." They remember the Great Depression, and Ben was a student of it.
On the contrary. We're still too failed to grow. It'll presumably happen, just not with the current cast of characters.
ReplyDeleteTFTG
Tom, You’ve correctly identified the big political problem that lies in the way of full reserve. But this is just bread and circuses all over again. I.e. when the public get used to something being supplied to them at a subsidised rate, they object violently when the subsidy is removed even when the main beneficiaries of the subsidy are the rich, and even when the subsidy makes no sense.
ReplyDeleteSo for that reason I’m going to continue arguing for full reserve. But you are right: we full reservers have a political problem to deal with.
Tom, Re your claim that “governments will not let depositors en masse take the hit”, it’s only depositors who are investing in mortgages and businesses VIA BANKS who take a hit. Depositors who want 100% safety and whose money is not invested (or is only invested in government debt) are not hit.
ReplyDeleteRe the idea that there would be a “a nuclear explosion in the center of the economy” that is totally untrue. It’s true that if depositors all think they are guaranteed to be repaid the exact sum they’ve deposited, and the suspicion arises that they won’t, then panic sets in. That’s an explosion.
In contrast, if the value of deposits simply declines, in the same way as the stock market suffers a set back from time to time, there is no panic and no “explosion”. As Mervyn King put it in that connnection, “We saw in 1987 and again in the early 2000s, that a sharp fall in equity values did not cause the same damage as did the banking crisis. Equity markets provide a natural safety valve…”
It’s also not true to say that central banks were introduced to deal with panics or bank failures. Central banks came into existence BEFORE it was regarded as the job of central banks to deal with panics. The actual reasons for the arise of central banks were very devious and political according to George Selgin in his book “The Theory of Free Banking”. See:
http://oll.libertyfund.org/index.php?option=com_staticxt&staticfile=show.php%3Ftitle=2307&Itemid=99999999
Selgin further argues that far from central banks solving bank panics, they are the cause of same. Reason is that the knowledge that central banks will bail them out, encourages irresponsible behavior by commercial banks.
Complicated stuff this, and don’t claim to have totally got my head round it!!!
Ralph - I'm not sure where stand on the issue of fractional reserve vs. full reserve banking other than that I know that fractional reserving makes banks vulnerable to bank runs during panics. I do find it somewhat counterintuitive and interesting though that your call for full reserve banking is more or less in sync with some Austrian school economists who advocate the same thing.
ReplyDeletehttp://wiki.mises.org/wiki/Full_reserve_banking
Aside from that agree with Selgin's comment you cite....
"Selgin further argues that far from central banks solving bank panics, they are the cause of same. Reason is that the knowledge that central banks will bail them out, encourages irresponsible behavior by commercial banks."
Black Swan author Nassim Teleb made a similar case in a recent interview on Libertarian Reason TV.
http://youtu.be/ehXxoUH1AlM