Should bank dividends be banned?

New appointee Jeremy Stein says yes:

Simply put, the government should force the banks to suspend all dividend payments," he told The Wall Street Journal in October.  "It makes absolutely no sense for the government to put money into the banks, only to see a significant fraction of it flow out again as dividends to shareholders, and in many cases, bank executives with large equity stakes."

I haven't seen much discussion of this issue.  Dividends are in general poorly understood by economists, in part because they continue to be paid when they face a significant tax disadvantage.  Surely there are cheaper ways to signal the quality of the firm.  One way of thinking about dividends is as a way to take advantage of bondholders.  Start a new firm, borrow $50, issue $50 in equity, and on day one pay $100 in dividends and by 4 p.m. declare bankruptcy.  Not a bad business model but of course neither the government nor the bondholders will let you.  This same strategy is also a way to take advantage of government subsidies and recapitalizations, even if you can't get the dividend up to one hundred percent.  So yes, I do see a case for following Stein's suggestion, at least for banks receiving government assistance above some threshold measure.

Stein, by the way, also favors this:

He advocated aggressive government audits of banks, aimed at separating
solvent ones from insolvent ones. Once that was done, insolvent banks
would be forced into closure or sale while solvent ones would be pushed
to raise more private capital. In addition to dealing with the bad bank
problem, putting the plan in place would remove much of the uncertainty
in financial markets that the government’s ad hoc approach to banks
thus far has helped instill.


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