OTHER VOICES
Market Discipline Is Not the Answer
By CHRISTOPHER T. MAHONEY
Letting big financial outfits collapse is a big mistake.
THERE'S A GROWING CONSENSUS ON both sides of the Atlantic that market discipline must be reintroduced into the financial system. Regulators have advocated that steps be taken to make it possible for large banks to fail, at a loss to depositors and other creditors, to end the policy that some banks are "too big to fail."
This view, while appealing to adherents of free markets, is nonetheless very dangerous. At times of crisis, the failure and default of a systemically important institution will lead to contagion and a run on the financial system, necessitating a systemwide rescue or precipitating a financial collapse with unknowable consequences.
Tim Foley for Barron's
Letting major institutions fail during times of crisis might sound logical, but the resulting panic could devastate the financial system.
The history of financial crises is the history of the threatened failure of financial institutions previously considered systemically unimportant. Runs occur on solvent banks during panics because there is insufficient information in the public domain to allow depositors to discriminate between the strong and the weak. Bank accounting is complicated, backward-looking and inexact. Who really knew in September 2008 what Lehman Brothers' true solvency was -- or Goldman Sachs', for that matter?
Every financial crisis in the past two centuries began with the threatened failure of a second- or third-tier institution: Barings in 1890, Knickerbocker Trust in 1907, Bank of United States in 1930, Yamaichi Securities in 1997, Long Term Capital Management in 1998 and in the most recent crisis, IKB, Northern Rock, Hypo Real Estate, Bear Stearns, AIG, and Lehman.
In every case, either the authorities allowed the threatened institution to fail, resulting in a full-blown systemic crisis, or the authorities blinked, ignored their own rules, and mounted an extra-legal rescue to protect the system.
Leading up to crises, the regulatory emphasis has been on market discipline, but by mid-crisis, the entire system ends up under the safety net. No one would ever have imagined in 2006 that every building society in the U.K. was "too important to fail," but they were so deemed.
If systemically unimportant institutions must be rescued to prevent panic and mass contagion, obviously the largest institutions have to be rescued, regardless of whether such rescues are allowed by law.
It is silly to suggest that every bank should be made so small that it can be allowed to fail in the midst of a crisis without systemic consequences. Such an atomized financial system would neither function nor be safe. The U.S. had an atomized financial system in 1930-33, and the result was catastrophe.
There is nothing wrong with maintaining "constructive ambiguity" about the size of the safety net, so long as this ambiguity is jettisoned when a system is in general crisis. It is safer and easier to set up the safety net before the first failure than it is to stop a mass run. That is the critical lesson of the catastrophic failures of the Bank of United States in 1930 and Lehman in 2008. The banking panic of 1930-33 would have been averted had the Fed rescued Bank of United States, and the panic of 2008 would not have occurred had Lehman been rescued and the safety net been extended to Wall Street, as indeed it was only a month later.
The European attitude toward this matter has been more pragmatic than that of the U.S. In Europe, when the recent crisis loomed, there was little consideration given to the "orderly default" option. Indeed, so far only one small bank has been allowed to default in continental Europe. In his book In Fed We Trust, Wall Street Journal writer David Wessel quotes a European Central Bank official as saying, "We don't let banks fail. We don't even let dry cleaners fail." True, refreshing, and wise.
In the U.S., the problem is complicated by a legal and regulatory regime designed to allow banks to fail, intentional ambiguity about the size of the safety net, laws that are intended to prevent bailouts, a regulatory distinction between banks and nonbanks, and strong political opposition to bailouts.
This unfortunate legacy resulted in the Treasury's conclusion that it lacked legal authority to rescue Lehman, a nonbank.
In the public dialogue concerning regulatory reform, there has been no discussion of the need to widen and strengthen the safety net. Consequently, when the next crisis occurs in the U.S., history will repeat itself.
The only solution to the systemic risk paradox is that countries must realize that:
- They are on the hook for their entire financial systems, whether they like it or not.
- The ultimate solvency of the financial system is a contingent liability of the government.
- Transparency and market discipline have never worked.
- The only practical solution is a strong safety net and competent prudential regulation of the entire financial system.
Since governments can't get off the hook for the financial system, the system must be much better regulated. This means insisting on less leverage, less reliance on market funding and more numerous and intrusive regulators. The cost of competent prudential regulation is much less than the cost of systemic bailouts.
CHRISTOPHER T. MAHONEY is a retired vice chairman of Moody's Investors Service.
Copyright 2009 Dow Jones & Company, Inc. All Rights Reserved
0 comments:
Publicar un comentario