Tag: bank bailouts

Where’s Our Bailout Vote?

It’s easy to forget that the financial crisis was not simply one of American financial institutions getting into trouble; banks around the world found themselves on the brink of failure.  One of the more interesting cases is Landsbankinn, a privately owned bank in Iceland.  Landsbankinn also operated a branch in Britain and the Netherlands called “Icesave.”  When Icesave failed in 2008, the British government rushed in and covered the deposits of its British savers — a move that was neither requested by Landsbankinn or the government of Iceland.  Now the Brits are demanding that Iceland pay them to cover those expenses.

For a brief moment it looked like that was exactly what was going to happen, as the legislature in Iceland passed a bill to pay off the Brits.  Sensing the public opposition, Iceland’s president blocked the bill.  This is likely to lead to a public vote by the people of Iceland on whether they want to cover the losses of British depositors in Icesave. 

Britain had no legal basis for seizing Icesave assets in the UK, nor did depositors in Icesave have any right to have their losses covered.  If England wants to bail out its citizens, that is its business.  Asking Iceland to foot the tab afterwards sets a dangerous precedent.

But then at least the citizens of Iceland are getting a vote on whether to bail out or not.  By comparison, both U.S. Treasury Secretaries Paulson and Geithner have decided that U.S. taxpayers must honor foreign investments in Fannie Mae and Freddie Mac, even if those investments were explicitly not insured by the U.S.  government.  Perhaps the U.S. could learn a little about democracy and accountability from Iceland.

The Cost of Government Guarantees

John Kay’s column in yesterday’s Financial Times criticizes government guarantees to banks because they involve hidden but large costs. According to Kay:

  • Such guarantees distort competition: sheltered banks outperform rivals not because of greater efficiency, but because capital becomes cheaper to obtain.
  • Sheltered banks gain too-big-to-fail status, which creates barriers to entry for smaller, more efficient banks.
  • Relief from business risk leads to more risk taking, AKA moral hazard.
  • Cheaper private risk management incentives are reduced within and outside the bank.

Other kinds of government guarantees, such as social insurance, also involve large hidden costs. Social Security and Medicare’s guarantee of a paid holiday with medical care for the rest of retirees’ lives generates the same types of costs:

  • Labor competition is reduced because the programs induce early worker retirements, which leads to higher wage costs, on average, and lower national output.
  • Workers who believe they will receive Social Security and Medicare will engage in lower personal saving, which means less capital formation and lower economic efficiency.
  • Retirement income guarantees induce riskier personal savings portfolios, AKA moral hazard.
  • Guaranteed retirement income means poorer financial knowledge and poorer risk management.

And now, retiree political power is too big to fail as well!

How come when Kay writes about market distortions from government guarantees for banks, he gets published; but when I do the same about government guarantees for people, I get the cold shoulder from editorial page editors?