The Receivership Option

Jeffrey A. Miron is a senior lecturer on economics at Harvard University.

Bailout 2.0, like its previous incarnation, is a dangerous gamble for the Treasury and the economy.

The argument for this program is that banks are paralyzed by their bad assets and low capitalization rates, so they are not lending even to creditworthy borrowers. But it is just as likely that banks are not lending because the economy is in recession, and banks rightly perceive that lending now is far riskier than in normal times.

These measures, in attempting to fix the current mess, will sow the seeds of the next disaster.

In this case, buying troubled assets or injecting capital will not necessarily increase lending. If it does, this increased lending will reflect inappropriate assumptions of risk. The taxpayers will be on the hook for any losses due to Treasury’s equity positions in the banks.

Likewise, the Fed’s extension of consumer and small businesses debt will be risky. It, too, is likely to encourage more risky borrowing, even though such borrowing (for mortgages) was at the core of the financial crisis. Thus bailout, in attempting to fix the current mess, sow(s) the seeds of the next disaster.

The one piece of good news is that Treasury plans to “stress test” the balance sheets of banks receiving bailout money, to determine if buying their toxic assets or purchasing their equity will make them healthy.

If the answer is no, the F.D.I.C. should force such banks into receivership, which means that shareholders will lose their stakes and creditors will become the new equity holders. In some cases such restructured banks would survive, and the F.D.I.C. could release them into the marketplace. In cases where the assets of the bank are worth less than the deposits, the F.D.I.C. would make up the difference and close the bank.

As drastic as this process sounds, it is the right step. It forces bank losses, to the maximum extent possible, on the shareholders and creditors who allowed the banks to assume excessive risk. Receivership also enhances transparency, a key ingredient of a smoothly operating financial system.

The receivership process does not guarantee banks will lend, since newly reconstituted banks might still find the economic climate too risky. But this is the only way to restore banks to health so that lending can resume once market conditions improve.

+++++++++++++++++++++++++++++++++++++++++++++++++++++++

Thank you Jeffrey, for this brief burst of clarity in an otherwise totally befuddled congregation of nations . . . and don’t forget–if banks refuse to lend, governments can!

You Should Also Check Out This Post:

More Active Posts: