"Calling the Big Banks’ Bluff" by Frank Schäffler and Norbert F. Tofall | Project Syndicate

"Calling the Big Banks’ Bluff" by Frank Schäffler and Norbert F. Tofall | Project Syndicate

Above all, the G-20’s decision to prop up systemically relevant banks must be revisited. And governments must respond to the banks’ threats by declaring their willingness to let insolvent banks be judged accordingly. A market economy must rest on the economic principle of profit and loss. An economy with neither bankruptcies nor a rule of law that applies equally to all is no market economy. The law that is valid for all other companies should apply to banks as well.

This is the Iv-B response to the crisis, to let banks collapse rather than the V-Bi one of propping them up as zombies.  

CommentsMoreover, governments should guarantee insolvent banks’ loans to non-financial companies, as well as private customers’ current, fixed-term, and savings deposits, by reforming insolvency laws. Certainly, governments should not guarantee interbank liabilities that do not affect customer deposits. An insolvency administrator would manage the bank and ensure that all payments for which a state guarantee is given are carried out properly, with refinancing of these payments continuing to take place via the central bank.

This is a V-Bi aspect of partial insurance, however there can be enough hidden chaos in the system to still bring it down. The problem is still not letting the I-O police and market do their job, they should compensate people who are deserving of insurance and not people who were dishonest in the crisis. The problem should not be moral hazard because this always occurs with insurance, but whether people acted in ways because of insurance that would justify canceling their insurance. For example banks that speculated in a risky way knowing they could become insolvent might not be insured.

CommentsAfter taking these steps, the payments system would be safe. In case of insolvency, a bank’s computers would not be turned off, its employees would not instantly be dismissed, and payment transactions would not collapse. Nor would a run on savings deposits occur, given the official guarantees that they remain unaffected by a bank’s insolvency. After all, even a simple banknote is money only because the government says so, and thus is no different from savings deposits, which means that no saver has an advantage from holding cash. So there would be no need for bank runs.

CommentsOf course, the deliberate restriction of the effects of bankruptcy to accounts other than private current, savings, and fixed-term deposits means that the insolvency of bank A could lead to the insolvency of bank B. For bank B, too, the same liquidation scenario would apply: savings deposits would be safe, payments could be made from its customers’ current deposits, and loans that it granted to non-financial companies would not be revoked.