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Goodmongo asked me
Its all a big game! I was reading an article in the New York Times about the European crisis. Here is the paragraph that gets me:
Last month, in perhaps the boldest move of the crisis, the European Central Bank lent $620 billion to banks for up to three years at a rate of 1 percent. Some officials had hoped that these cheap loans would spur demand for government debt. The idea is that financial institutions would be able to make a tidy profit by borrowing from the central bank at 1 percent and using the money to buy government bonds that have a higher yield, like Spain's 10-year bond at 5.5 percent.
Am I crazy or wouldn't it have been easier and cheaper to just laon those governments the money directly at the 1%? Why try to sanitize it by going through commercial banks?
My answer is:
Because that's the law. The basic idea behind it is that profit-maximizing banks would not finance a government that is not credit-worthy. It's a free-market argument. The hope is to prevent governments from printing money and thus using the inflation tax to finance expensive programs (like social welfare ! :).The problem now is that profit-maximizing banks aren't actually all that good at determining credit risks and are part of very short-sighted financial markets. And, of course, they are often run by managers who try to maximize their own profit instead of the bank's.Which way you do it is really a question of the lesser evil.
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But I'd like to make a larger point here. For decades now there is the narrative in the US that Europe is living in some kind of socialism-light. And while there are some reasons to think so, there are also quite some reasons to not think so.
For example the fact that many countries here have a flat tax. Here's a map. Or the fact that a country like Ireland has extremely low corporate taxes. Or the fact that rich people in some countries like Greece, but also like Italy don't actually pay taxes. Well, they should, but they don't.
So, the financing of government with the printing press, which enables politicians to spend as much as they like, is just one example where Europe is to the economic right of the US!
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But here's the funny thing: The countries which perform best in Europe tend to be the ones with a strong government (~45% public expenditure quota), like Denmark, Sweden, Finland, Norway.
The European experience right now is that what is most important for a society is the fight against corruption. If corruption is low (rent-seeking minorities and interest groups are weak), a large and expensive government financed in a way that wealth differences are kept low*, seems to be pretty good for the economy and the society as a whole.
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* progressive taxes that create a factor 30 instead of a factor 300 between a CEO's and an employee's income.
A clarification. My comment was since they were loaning the money wouldn't it be better to loan it directly. This should not imply that that it was a good idea to loan it in the first place.
ReplyDeleteI was against TARP and the other US government bailouts. And I agree that those bailouts were more socialist then capitalist. It was a game here in the US (the bailouts) to protect and remove the risk that the bankers had.
I would much rather had them fail and lose THEIR wealth then to have the taxpayers foot the bill.
That said I'm still curious what will happen in Europe. The article I quoted said that the various governments still need the money. If loaning to commercial banks to reloan to them doesn't work what is the next step? Will this eventually result in the Euro crashing and going away? Will Margret Thatcher eventually be correct?
If necessary the ECB will print money and lend it directly to the governments because otherwise the ECB-people would be unemployed the next morning.
ReplyDeleteReally, the ECB is the one institution that has the highest interest in the Euro not failing. And it has all the tools it needs to prevent it short term. If strictly necessary, rules and laws are irrelevant - and have been before in this crisis.
I said before: The only way the Euro can fail is if parties are elected in some countries which want out of the Euro. Until then the ECB will print as much money as needed. (But not say so openly, of course).
At the same time, the ECB will finance the governments through the banks as long as possible - and thus within the law. And, especially today, it looks like this is working well enough.
Will the Euro fail? Well, Anti- Euro parties have become stronger since the crisis has begun, but they are still far from governing major countries. So, yes, the Euro might fail; but if it does then in many years.
"And, of course, they are often run buy[sic] managers who try to maximize their own profit instead of the bank's."
ReplyDeleteIts not really the government's job to correct this problem, its the investor's job. What motivation do investors have to reform compensation if their losses are being subsized by tax payers anyway? That is where free-market reforms break down due to government manipulation.
What motivation do investors have to reform compensation if their losses are being subsized by tax payers anyway?
ReplyDeleteA major problem. It originates in the fact that banks can become so important for an economy that allowing them to go broke in a chain reaction becomes unacceptable for society.
The free market doesn't really offer solutions, as far as I know.
To that i'll quote ex FDIC chair Sheila Bair...
ReplyDelete"The truth is, some of us did see this coming. We tried to stop the excessive risk-taking that was fueling the housing bubble and turning our financial markets into gambling parlors. But we were impeded by the culture of short-termism that dominates our society. Our financial markets remain too focused on quick profits, and our political process is driven by a two-year election cycle and its relentless demands for fundraising."
To use a musical chairs analogy...politicians dont want the music to stop when they are in office so they will employ any means necessary to put it off and let the problem grow.
I agree. Politicians behave pretty predictably here. That's why we need systems that correct the problem.
ReplyDeleteHoping for people who want to be re-elected to let banks go broke or end the party while they can is useless.
Banks don't "go broke". In the US there is the FDIC to protect all the small investors. If a bank fails they sell their remaining assets to another bank and that bank takes over.
ReplyDeleteIn the rare case of a bank not being able to sell their assets a quasi-governmental agency takes over and sells the assets to other banks/people and then pays off any creditors with the remaining funds.
Failure is a natural thing. Trying to prohibit failure is what is wrong. Or are you now disagreeing with Ron Paul? He's completely against bank bailouts and is actually against the whole FED system in the US.
Since when do I agree with Ron Paul on economic policy ? :)
ReplyDeleteI just think that he is the most (only?) honest of the candidates and would create a very interesting and badly needed debate in the US if he ran against Obama (which is highly unlikely).
When I say 'broke' then I am talking about the management being punished financially for their mistakes. Not whether the institution continues to exist in some way or form.