Month: March 2009

The banking crisis as a foreign policy issue

by  Tyler Cowen in

Here is some simple background:

If we let A.I.G. fail, said Seamus P. McMahon, a banking expert at Booz
& Company, other institutions, including pension funds and American
and European banks “will face their own capital and liquidity crisis,
and we could have a domino effect.” A bailout of A.I.G. is really a
bailout of its trading partners – which essentially constitutes the
entire Western banking system.

No one wants to say it, but essentially the Fed has been bailing out European banks. 

The inflation-adjusted cost of the Marshall plan has been estimated at about $115 billion in current dollars.  If we end up spending $250 billion on AIG, how much of that sum will go to European financial institutions and might it someday exceed the scope of the Marshall plan?  (I do not, by the way, think that central banks ought to treat foreign creditors differently.)

One attempt to formulate a bailout plan for eastern Europe just failed.  This is round one in a series of longer negotiations.  As the European financial crisis worsens, and Germany asks itself whether it will bail out Ireland and Hungary and maybe others, it will become increasingly clear that major foreign policy crises are afoot. 

The best actual marker of the progress of the financial crisis is not stock or real estate prices, but rather how well international cooperation holds up.

I wish to thank Michael Mandel for a conversation related to these topics.

Scott Sumner’s open letter to Paul Krugman

by  Tyler Cowen in

Here is the excellent Scott Sumner: an open letter to Paul Krugman.  It's also the best recovery plan I've seen so far, by far.  It's too good to excerpt, so you'll have to click through and read the whole thing.  From my point of view, right now the whole world should be beating a path to Scott Sumner's door.

He has two unpublished book manuscripts and he probably would be free to meet with President Obama as well.

A new theory of suicide

by  Tyler Cowen in

This morning I read this:

In essence, Joiner proposed that people who kill themselves must
meet two sets of conditions on top of feeling depressed and hopeless.
First, they must have a serious desire to die…Second, and most important, people who succeed in killing themselves must be capable of doing the deed.

Maybe it’s the fault of the press coverage (remember when Modigliani won the Nobel Prize?…”people save for their old age”) but then I thought of this.

Why the banking sector is hard to fix

by  Tyler Cowen in

Here is my latest column, excerpt:

The second set of solutions involves taking control of insolvent banks, either by nationalizing them or declaring them bankrupt. In the past, the Federal Deposit Insurance Corporation has used the model of rapidly shuttering failed banks, and it has usually worked.

Many
analysts cite Swedish bank nationalization, from the early 1990s, as a
model, because the Swedes later reprivatized these banks and resumed
economic growth.

But Sweden nationalized only two banks. And the
Swedish banks were much smaller and easier to run than the largest
United States bank holding companies, which combine a wide range of
complex international businesses, commercial paper operations, derivatives trading and counterparty commitments.

It
is quite possible that the reputation of a nationalized bank would be
so impaired that it would incur even greater losses as its web of
commercial dealings collapsed. These far-reaching commitments are a
reason that the F.D.I.C. model of rapid shutdowns cannot be applied so
easily here.

The most obvious problem with nationalization is the
risk of contagion. If the government wipes out equity holders at some
banks, why would investors want to put money into healthier but still
marginal institutions? A small number of planned nationalizations could
thus lead to a much larger number of undesired nationalizations.

On top of that, the government doesn’t have the expertise to run large bank holding companies like Citigroup.
There is the danger that caretaker managers, with bureaucratic
incentives, will never return the banks to profitability. And
restrictions on executive pay, already enacted into law, will make it hard to hire the necessary talent.

In
the meantime, there would be increasing pressure to politicize lending
decisions – for instance, by requiring loans to the ailing automobile
industry. Talk of taxpayers capturing an “upside” is probably
unrealistic.

The plight of the American International Group,
the giant insurer, provides a cautionary tale. The government has
already effectively nationalized A.I.G., but after a government
commitment of $150 billion, the company’s losses continue to mount, and
there is no simple way to either manage it or split it up. If the
government cannot run that bailout very well, how can it run major
banks and nurse them back to profitability?

Nationalization
also puts bank debts on the balance sheet of the government without
restoring bank solvency. Once the government takes over, it is hard to
reorganize the debts of these companies without damaging the
government’s own creditworthiness and spreading the insolvency to bank
creditors. Yet if the banks are insolvent, paying off the creditors may
cost trillions.

It is becoming increasingly clear that the question is not whether to nationalize but rather whether we can afford to make whole long-term bank creditors.  Megan McArdle has some thoughts.  How much do we gain by transferring the losses away from banks and toward Europeans, insurance companies, and pension funds?  If the worst-case scenarios really are true — and they may be — that is the next question on tap.  It is of course a very ugly question.