Saturday, 14 September 2013

Bank losses cause chaos, while far larger losses by other entities cause no problems!!!!

The total losses made by ten US banks that made the biggest losses which sparked off the credit crunch lost a total of £127bn. That caused chaos.
In contrast, the total lost when the tech bubble burst was $6.8trillion:

Yet the tech bubble burst didn’t cause anywhere near the same disruption as the above bank losses. In short, trillions wiped off equity values does not cause much of an upset. (Incidentally I got those figures from Stumbling and Mumbling, and the figures seem to be about right to judge from other sources.)
That supports the claim made by numerous people and groups, namely that wherever a depositor or other bank creditor wants their bank to lend on or invest their money, the depositor should carry the risk involved in that investment. That way, those depositors in effect become shareholders or equity holders.
The people and groups advocating the latter policy are several. E.g. Laurence Kotlikoff, John Cochrane, Positive Money, New Economics Foundation, Prof. Richard Werner, etc. For the last three, see here.
Or in the words of Mervyn King, "...we saw in 1987 and again in the early 2000s, that a sharp fall in equity values did not cause the same damage as did the banking crisis. Equity markets provide a natural safety valve."
That just leaves the question as to whether we impose capital buffers which make bank insolvency almost impossible, (perhaps around 20% of total bank liabilities) or whether we force ALL BANK CREDITORS to be loss absorbers. The arguments for the latter policy are as follows (for the benefit of the 0.1% of the population who appreciate logic).
No matter how large capital buffers are, if they are not 100%, there is a finite chance of the bank failing.
The taxpayer can cover that risk, but that amounts to a subsidy of banks, and subsidies misallocate resources.
Alternatively, non-risk bearing depositors can be insured, with depositors paying the premium, but the insurance premium will equal the additional interest that such depositors get from placing their money in a commercial bank as compared to something 100% safe, like monetary base or short term government debt. I set out the reasons for the latter point here.

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