Let banks fail, says Nobel economist Joseph Stiglitz

http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/4424418/Let-banks-fail-says-Nobel-economist-Joseph-Stiglitz.html

The Government should allow every distressed bank to go bankrupt and set up a fresh banking system under temporary state control rather than cripple the country by propping up a corrupt edifice, according to Joseph Stiglitz, the Nobel Prize-winning economist.

Professor Stiglitz, the former chair of the White House Council of Economic Advisers, told The Daily Telegraph that Britain should let the banks default on their vast foreign operations and start afresh with new set of healthy banks.

"The UK has been hit hard because the banks took on enormously large liabilities in foreign currencies. Should the British taxpayers have to lower their standard of living for 20 years to pay off mistakes that benefited a small elite?" he said.

"There is an argument for letting the banks go bust. It may cause turmoil but it will be a cheaper way to deal with this in the end. The British Parliament never offered a blanket guarantee for all liabilities and derivative positions of these banks," he said.

Mr Stiglitz said the Government should underwrite all deposits to protect the UK's domestic credit system and safeguard money markets that lubricate lending. It should use the skeletons of the old banks to build a healthier structure.

"The new banks will be more credible once they no longer have these liabilities on their back."

Mr Stiglitz said the City of London would survive the shock of such a default because it would uphold the principle of free market responsibility. "Counter-parties entered into voluntary agreements with the banks and they must accept the consequences," he said.

Such a drastic course of action would be fraught with difficulties and risks, however. It would leave healthy banks in an untenable position since they would have to compete for funds in the markets with state-run entities.

Mr Stiglitz's radical proposal is a "Chapter 11" scheme for households to allow them to bring their debts under control without having to go into bankruptcy. "Families matter just as much as firms. The US government can borrow at 1pc so why can't it lend directly to poor people for mortgages at 4pc. ," he said.

Do you agree with him?

Also, what about Browns argument that, other governments around the world bailing out their banks shows that it is the right course of action?

Reply 1

Anony mouse

10

I think Joseph Stiglitz has a good point and people who disagree such as the Government ought to consider the following:

The Moral Hazard theory

Moral hazard is the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk. Moral hazard arises because an individual or institution does not bear the full consequences of its actions, and therefore has a tendency to act less carefully than it otherwise would, leaving another party to bear some responsibility for the consequences of those actions.

How does this relate to the current financial situation?

In standard economic markets, the lender bears the consequences of a loan given to another party, which may then go bankrupt if the loan was put towards a bad investment. Instead however, we are in a situation whereby governments are seen to be creating huge financial rescue packages otherwise known as ‘bank bail-outs’, to fund creditors of bad investment. In anticipating a bail out, the creditors have a weaker incentive to insure that their borrowers are able to repay their loans. So such free insurance reduces the bank’s care to be prudent as the banks expect to be bailed out by the government when in financial crisis. At the same time as borrowers are not encouraged to purchase insurance to minimise their own risk of bankruptcy, they then incur excess exposure to further deficit and not need to worry about it.

The government justifies this practice by claiming that without it banks and borrowers would become bankrupt and face an almost impossible task of obtaining credit in the future. However there is a fallacy in this notion. If creditors know that they bear the full consequences of bad loans, they will fully analyse the risks in order to assess what interest rates to charge. If the heavier debts are discharged, the country is more able to pay back on some of the loans. This is the premise for bankruptcy in the first place – the discharge or restructuring of debt allows firms and countries to move forward. History would support this scrutiny. The firms that do not buy insurance against the collapse of the economy cause the financial crisis, due to the defaulting of payments and seizure of lending. In this way, the bail outs are part of the problem and exacerbate the very problem that they are designed to resolve.

Reply 2

toonbarmy

Ok I do not understand the finer nuances of our economy but in the short term, letting banks fail would be cataclysmic however in the future it could work. I say this as I believe the government is obligated to protect the publics money in whatever banks are around, so letting them fail would be fine as they would be subsidised. However due to this, wouldn't the government and the country in general be taking a massive hit to set up new banks and restoring us to former glories.

Please feel free to pick this apart, as I said I do not know much about this so any experts please educate lol!

i agree.

I think that's a (to put it bluntly) load of ********.

It's all very well to talk about the City surviving due to it retaining some semblance of free-market responsibility, but I have no doubt that it'd be hit harder than a nuclear strike. I'd be amazed if there were even 'skeletons' of the banks left to build from, seeing how close they all came to oblivion after the failure of ONE bank across the pond. Imagine what would happen if the Government suddenly said "right, screw it, your deposits are safe but the bank is on it's own". Credit would stop (yet again...) which would help fan the raging flames of this current meltdown.

Sure, in the long-term things would get better. But wouldn't we just forget the current crisis sooner or later? As new generations inherit the banking system, the lessons learnt from this generation will be eroded sheerly due to time. I mean, check out the great depression - by the proposed logic, all banks would have been ultra careful with their assets, but the exact reverse happened.

Finally, any attempt for a country to take unilateral action on this crisis is futile, stupid and shouldn't be encouraged in any way, shape or form. What's needed NOW is a concentration on nationalisation of banks and multilateral fiscal boosts to help the economy from going flat-lining. Later, the banking system can be properly reformed - hopefully with increased state intervention - but that's a goal that we have to set aside for the moment.

Reply 5

jacketpotato

20

Anony mouse

If creditors know that they bear the full consequences of bad loans, they will fully analyse the risks in order to assess what interest rates to charge. If the heavier debts are discharged, the country is more able to pay back on some of the loans.

I don't think this theory is convincing when applied to the present situation. When looking at the causes of the crisis, I don't think there is any truth in the statement that people took on excessively high risks because they knew if they failed they would get bailed out. The problem was that the risks which were taken on became so remote, that banks ended up taking on much greater risks than they initially thought.
Moreover, I don't think it would really affect banks at all in the future if they weren't bailed out. Its mythical to say that government bail-outs really encourage excessive risks: needing a bail-out is a very bad place to be in, not a place that any bank would ever want to put itself in. Banks always plan for their investments to be at least semi-successful, the rather dodgy idea of a government bail-out is such a low safety net that it makes no real practical difference.
Not to mention that banks aren't stupid: they know that a future government won't bail banks out if it becomes apparent that the 'moral hazard' theory is actually correct!
The lessons of this crisis will have been learnt for future generations, banks will become more cautious in future whether or not they are bailed out.

This is the premise for bankruptcy in the first place – the discharge or restructuring of debt allows firms and countries to move forward. History would support this scrutiny. The firms that do not buy insurance against the collapse of the economy cause the financial crisis, due to the defaulting of payments and seizure of lending. In this way, the bail outs are part of the problem and exacerbate the very problem that they are designed to resolve.

This ignores the practical impact of bankruptcy. It screws over the bankrupt's creditors. Given that the banking system is very much inter-dependent, it stops money-flows and consequently spirals. This is a very bad thing for the economy, the public sector included!

Reply 6

Anony mouse

10

jacketpotato

This ignores the practical impact of bankruptcy. It screws over the bankrupt's creditors. Given that the banking system is very much inter-dependent, it stops money-flows and consequently spirals. This is a very bad thing for the economy, the public sector included!

Unfortunately I cannot counter your argument convincingly as economics is not really my forte. Then again, I’d argue that most of us do not truly understand economics. :eek3:

Reply 7

she

16

I've been saying this from the beginning. Where's my recognition? :p:

Reply 8

gyyy2807

14

Stiglitz makes a good point, but I think that if we let the banks fail, then it'll take time to build up a banking system again and during that period the broader economy will be hugely affected.

Reply 9

jacketpotato

20

Anony mouse

Unfortunately I cannot counter your argument convincingly as economics is not really my forte. Then again, I’d argue that most of us do not truly understand economics. :eek3:

Indeed - I don't think even the economists do :woo:

Its all very speculative and theoretical, I don't think anybody REALLY knows what would happen if we do and if we don't bail out the banks!

Reply 10

Richard-16

Joseph Stiglitz is a pleb.

Reply 11

HappinessHappening

4

He's dead right; our entire banking system needs to be replaced.

Reply 12

LoveYourSlavery

OP

What if the banks fail despite the bailout? Also does anyone know what the banks are doing with the bail out money, or is that open to speculation i.e. we don't know.

Reply 13

Howard

5

Not sure. Maybe he's right. But allowing the banks to fail would be a terrific gamble.

Reply 14

Rob 106

7

Meh, it's tough.

Banks should not be able to take huge risks and then rely on the people to back them up, especially as they then spend loads of OUR money on massive bonuses.

But could we really let a bank collapse, and have people loose all their money?

I guess we should, tho i wouldn't like to have to take responsibility for that decision!

Reply 15

weflycars

8

Richard-16

Joseph Stiglitz is a pleb.

Your mum is a pleb, you honestly haven't looked at what he's saying have you..

If the state could manage to run an effective bank temporarily then it's a brilliant idea, the billions spent on bailouts could be used to set up a new system, then they could privatise it when it was stable and regulate it heavily to stop greedy capitalist fat cats ******* things up again..

Reply 16

Richard-16

weflycars

Your mum is a pleb, you honestly haven't looked at what he's saying have you..

If the state could manage to run an effective bank temporarily then it's a brilliant idea, the billions spent on bailouts could be used to set up a new system, then they could privatise it when it was stable and regulate it heavily to stop greedy capitalist fat cats ******* things up again..

Shut up fool. He doesn't know anything.