Saturday, 7 March 2009

Banks - either public utilities or private sector businesses without safety nets - but not both

Martin Wolf argues strongly that the costs to the UK of being the insurer of last resort as implied by the government's Asset Protection Scheme are becoming dangerously high. The government has to make a choice. On the one hand it has to accept that losses from a modern banking system will always be too large and systemically disruptive that they will have to be socialized in which case banks should effectively become state owned utilities. Or if the government mandates that they need to remain in the commercial/private sector, then there needs to be a mechanism by which failure and re-structuring can take place. The government can no longer have it both ways.
Here is an excerpt from Martin Wolf's excellent article

We must create effective mechanisms for orderly bankruptcy of very large financial institutions. Indeed, this is far and away the most important lesson of the crisis. Another is that if large institutions are too big and interconnected to fail, precisely because they are bound to get into serious trouble together, then talk of maintaining them as “commercial” operations, as the chancellor of the exchequer does, is a sick joke. Such banks are not commercial operations; they are expensive wards of the state and must be treated as such.

The UK government has to make a decision. If it believes that costly bail-out must be piled upon ever more costly bail-out, then the banking system can never be treated as a commercial activity again: it is a regulated utility – end of story. If the government does want it to be a commercial activity, then defaults are necessary, as some now argue. Take your pick. But do not believe you can have both. The UK cannot afford it.

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