I don't mean to pick on Kevin Drum, whom I really admire (and who offered a very nice response to my previous piece). But in the post I already picked on, he wrote this...

So what are the lessons [of the Swedish experience] for us? ...[W]e could consider a systemwide guarantee of all bank obligations, instead of the one-offs we've (partially) applied to Citi and BofA.

And then I read this (ht Felix Salmon):

Another top option under discussion would be to broaden a technique the government has already used in its rescue of Citigroup and Bank of America. In both instances, the government agreed to share losses with the banks on a certain group of assets. The banks agreed to take the first hit, and taxpayers are on the hook for much of the rest. In the case of Citigroup, the total amount of assets protected is more than $300 billion. This loss-insuring plan under discussion would be available to banks large and small. Ms. Bair said she and other regulators are keen to provide sweeping solutions instead of the ad hoc approaches of last year. Officials don't agree, though, on whether guarantees could be offered broadly, given the complexity and variety of instruments held by many institutions.

I think it is very important to point out that what we have done as "one-offs" for Citi and Bank of America bears absolutely no resemblance, and is quite opposed in spirit, to what the Nordics did during their banking crisis. Yes, Sweden issued a blanket guarantee of bank obligations. That was a bail-out to customers and creditors of Swedish banks, who otherwise might have seen deposits lost or loans defaulted.

What the US has done for Citi and Bank of America is put a floor under the value of the particular "toxic" assets. That means the government takes the loss before shareholders do. In Sweden they bailed out the creditors, but insisted that the stockholders, and at least in the case of Nordbanken the management, take losses before taxpayers. In the hypercapitalist US of A, we prefer to bail out creditors, stockholders, and management, full stop.

Guaranteeing obligations is arguably necessary as a means of protecting the financial system and the economy at large. Guaranteeing assets is a means of protecting incumbent institutions that might otherwise participate in the miracle of creative destruction.

If I had any more capacity for apoplexy, I would go totally apoplectic about a proposal to institutionalize transfers targeted at the most negligent and devious stakeholders in the banking crisis. Fortunately, my brain exploded months ago.

Steve Randy Waldman — Sunday January 18, 2009 at 8:21pm permalink
RueTheDay (mail):
Wow Steve, you're on a roll this weekend. Great to see you posting frequently.

I would further separate the "obligation guarantees" into three categories - deposits, interbank loans, and bonds. There is a very strong case for guaranteeing deposits, a moderately strong case for guaranteeing short term interbank lending, and a weak case for guaranteeing bonds. The first two are crucial for preventing the collapse of the banking system, but not bonds. Bondholders muct carry some risk, else they ought to be buying Treasuries.

I's also like to hear your thoughts on the backstopping of the money market funds. Not a lot in the news about that lately. I understand why it needed to be done, but it should have been done under the condition that that whole segment of the shadow banking system would be brought under FDIC/OTS control.
1.18.2009 9:07pm
It's great that Felix Salmon mentions the "complexity and variety of instruments held by many institutions."

We still don't know if the Fed and/or Treasury has good visibility into the various and sundry obligations of the banks. If financial armageddon is still avoidable, guaranteeing - and probably having to make good on - tens of trillions of dollars in toxic instruments that should never have been created in the first place will no doubt seal our fate. Talk about a cure being worse than the disease. This is indeed beyond apoplexy.
1.19.2009 3:33am
Benign Brodwicz (mail):

It is a very sad time for our country. The distributional scrap ahead promises to be ugly. I pray that our government will undo some of the damage. They can pass another law, can't they?

I pray that our government, perhaps under divine inspiration, can come up with a new social contract--in a hurry--one that people can believe in. See Strauss and Howe's brilliant Fourth Turning
for more on this.

Nice work, Steve. Keep the faith.
1.19.2009 12:53pm
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