Monday, February 23, 2009

Ideas for getting the world) banking system working

Martin Wolf and Will Hutton discuss some ideas in a gripping MP3 I have just pointed to on my pod page.

Here's another one:

"Governments should promise to buy twice the number of outstanding bank shares in 5 years at twice their recent prices. Markets would immediately price-in this pledge, and the resulting price boom would allow banks to raise necessary capital from private sources."

It's neat, but the problem - as I see it - would be moral hazard. Why run a bank well or safely when you know its share price will double anyway?

Here's a better one:

"Capitalize half a dozen start-up wholesale banks with government money – call them Hamilton, Jefferson, Franklin, Madison, Adams and Washington. Get them borrowing and lending freely, purchasing assets from legacy banks, and then, equally swiftly, sell them off – privatize them."

The idea would be not to help out the bad banks. Let 'em die. Instead start new ones which would form the backbone of a working financial system.

I like the sound of it. A lot.


Anonymous said...

I think the only problem with killing the bad banks is that no one still has an idea about what would happen with CDSs. Even though the Lehman one went OK, there's still a huge fear about what might be exposed.

But the latter option certainly seems the most sensible.

derrida derider said...

The trick with the "offer to buy in five years" bit is to pitch the offered price so it will only be a FLOOR - if things go well the call option will not be exercised (of course, how to treat these share options in the government's accounts is an interesting question). So you're only eliminating downside risk, not upside.

ozrisk said...

Several problems with that - the incentives would be for banks to change their dividend policy to pay out as much in dividends as they possibly could as well as increasing salaries as much as possible. Both of these would increase the government's downside risk. There are many other possible incentives built in, but those will do for a start.
The problem with the second idea is how you avoid creating the situation we now have - i.e. what is to stop the new banks doing the same as the old ones? The new ones are going to, as you said, borrow and lend freely. If you restrict them to only certain assets classes (say government bonds and home loans) then you restrict the supply of loanable funds to other classes - dropping the price of favoured sector lending and increasing the price of all other sectors, particularly as the new banks could be expected to carry at least an implicit government guarantee.
Additionally, the over-lending into the US housing market was at least in part driven by government policy to direct lending in this way. The results are apparent. To me at least directing credit in this way is not the way we should be going.

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