Thursday, December 8, 2011

08/12/2011: Let the failed banks fail

John Cochrane on Europe's banking crisis:

"What financial system will we reconstruct from the ashes? The only possible answer seems to me, to go back to the beginning. We'll have to reconstruct a financial system purged of run-prone assets, and the pretense that nobody holds risk. Don't subsidize short-term debt with a tax shield and regulatory preference; tax it; or ban it for anything close to "too big to fail." Fix the contractual flaws that make shadow bank liabilities prone to runs."


"For nearly 100 years we have tried to stop runs with government guarantees--deposit insurance, generous lender of last resort, and bailouts. That patch leads to huge moral hazard. Giving a banker a bailout guarantee is like giving a teenager keys to the car and a case of whisky."


"European banks have all along been allowed to hold sovereign debt at face value, with zero capital requirement. It's perfectly safe, right?"


Read the full note here.

1 comment:

Gav Roche said...

Basel 3 was the perfect moment to agree that sovereign debts should not be held at face value.

We missed the boat there and have recreated the problem that led us to where we are -underprovisioned public debt.

This sovereign debt crisis would not be nearly so disastrous if banks were providing for sovereign defaults, but instead they are borrowing cheap money from the ecb, buying risky sovereign assets and look set to either make a massive windfall if the Euro pulls through or deliver the bill to taxpayers if it does not.