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September 21, 2007

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Bob B

"the state should not intervene to support ailing private companies. Many rich bankers disagree."

Of course. That's hardly surprising when state intervention in banking in the event of failures helps the banks to earn greater rewards because the banks can comfortably accept more risk when they lend if they feel assured that they will always be bailed out. Naturally, rich bankers like that. We have been here before:

"The Savings and Loan crisis of the 1970s and 1980s was a wave of savings and loan association failures in the United States in which over 1,000 savings and loan institutions failed in "the largest and costliest venture in public misfeasance, malfeasance and larceny of all time."[1] The ultimate cost of the crisis is estimated to have totaled around USD$150 billion, about $125 billion of which was consequently and directly subsidized by the U.S. government, which contributed to the large budget deficits of the early 1990s. The concomitant slowdown in the finance industry and the real estate market may have been a contributing cause of the 1990-1991 economic recession."
http://en.wikipedia.org/wiki/Savings_and_Loan_crisis

Only fools don't learn from their own past mistakes. Wise men do, which is perhaps why we are where we are regarding pressure on the Bank of England to bail out financial instituions which fail because of their own business model.

sanbikinoraion

Your (1) is very much of the form "I know this one rich guy, he's a wanker. Therefore, all rich guys are wankers."

Or, just because these rich guys are not libertarians, does not mean that all rich guys are not libertarians.

David Farrer

By George, I Think He's Got It!

John G

This is unusually poor reasoning.

Besides, the rich are libertarians largely because it suits them: it is they who benefit most from 'negative' freedoms.

I suspect it gives most people who could be described as libertarian far too much credit to suggest that after long and hard reflection they are ideologically or morally wedded to the philosophy. It just works out best for them.

And so when occasions arise on which it doesn suit them to be libertarian ... they aren't.

Dipper

Despite reading this column regularly I still don't think I understand economics.

Perhaps some smart economically literate person can explain to me how lots of pensioners losing their life's savings teaches rich bankers a lesson?

Bob B

It's a no brainer but rest assured, if tax payers keep bailing out failing financial institutions even more financial institutions will fail in future and more tax payers money will be spent bailing them out too. And some bankers will get even richer with the knowledge that in future they can make more risky loans in the hope of getting bigger rewards with the expectation that their banks will be bailed out if anything goes wrong.

Mainstream economics texts warned of the consequences of guaranteeing bank deposits long before the downstream problem of the burgeoning sub-prime mortgages blew up. What they said would happen has come to pass. This is why the Bank of England reacted in the way it did.

Press commentary has often been politely circuitous - or circumspect - in questioning whether Northern Rock is a "deposit taking institution" at all rather than "an arbitraging operation between different segments in the (vast) market for loans".
As reported, only a quarter of Northern Rock's mortages were funded through cash deposits and the remainder through borrowing wholesale on the money market, which is why it came unstuck as banks (or deposit taking institutions) became reluctant to lend to other financial institutions for longer than a day for fear of being left holding duff collateral initially spun out by American institutions which had bought in securitised sub-prime mortgages. Btw it really is amazing how America, with so many Nobel laureates in economics, gets us into these situations - as remarked above, we have been here before with the Savings and Loan Associations debacle of the 1970s and 1980s.
The Bank of England had no special obligation to rescue whatever Northern Rock was from the consequences of its own business model. The Bank of England (rationally) changed course this week when it became evident that the immediate risks from a contagious spread of failing confidence in financial institutions outweighed more distant risks from moral hazard - namely financial institutions subsequently engaging in more risky lending in the search for greater rewards with a newly found expectation that the Bank of England will always bail them out if (or when) market events become unpropitious.
But then we also have to contend with the great Northern lobby and its determination to believe that London is engaged in a permanent conspiracy against the north, as well as the Scottish lobby, which believes there is a perennial English conspiracy against Scotland and is determined to ensure that whoever is found to be at fault for all this, it won't be Gordon Brown or Alistair Darling, who are both Scots.

Dipper

sorry but this is just bullshit of the highest order, and the comments about the north/scotland make it offensive bullshit too.

When I've calmed down I'll write more on what an utterly stupid comment that is.

wayne

Rich people could be libertarians especially if libertarians stand for the free movement of people because that allows that to pay ever cheaper wages.

Dipper

and Bob B, you didn't answer the question.

If Darling had not intervened then NR would have been bust, A&L and B&B close to collapsing, and the system creaking.

And the bankers would now be sitting regeretting their foolish risk taking.

But they wouldn't! Because they've already got the loot! And the recession would make their loot worth more!

Stop talking about institutions and talk instead about people and their reactions and lessons.

And Darling hasn't finished yet, so criticism of the government action is premature.

Bob B

"and Bob B, you didn't answer the question"

But I did answer the question - as well as spelling out the downstream consequences of depositer protection.

We have been here before with the S&L Association debacle in America, which is precisely why the previous standing arrangement for depositer protection in Britain didn't provide 100% protection for all depositers in deposit-taking financial institutions all the time:

"If you have up to £35,000 on deposit then you would, in the event of insolvency, get back all of the first £2,000 in your account and 90% of the next £33,000.

"That would be a total of £31,700 per person in compensation, or to look at it another way, a loss of £3,300.

"But any money above the £35,000 threshold might be lost altogether."
http://news.bbc.co.uk/1/hi/business/6994746.stm

If Gordon Brown and Alistair Darling as successive Chancellors regarded that as insuffficient protection, then why didn't they change it to guarantee all deposits, all the time?

With New Labour in government, they had enough time to do so and had they done so, then depositers in NR and then the other institutions facing deposit withdrawals wouldn't have had problems? Would they?

As Darling has left it, the government has backed all the deposits of NR and will back all the deposits of other banks with similar problems. What we don't know yet is whether such universal guarantees are to be a permanent standing arrangement. Are they?

An any event, there is a good case for arguing that NR's business model wasn't that of a typical mainstream deposit-taking financial institution and that is why it ran into problems when the costs of borrowing in the inter-bank market rose so steeply because of failing trust between banks in Britain as the direct consequence of the securitised sub-prime mortgages spun out of American financial institutions.

What's Darling going to do about this looming threat to sub-prime mortgages in Britain?
http://money.guardian.co.uk/news_/story/0,,2173873,00.html

Rob Spear

Since the powerful, if not the rich, are generally "of the left", I guess that your first statement makes libertarianism "of the right", whereas your second contradicts it. Or maybe labeling political ideas left and right is just pointless, and leads to a state of continual revolution.

Dipper

Well Bob

What we currently have now is a situation where building societies are full of people moving their money around so that they have a max of £30,000 in lots of institutions. In fact, I'm, off in a minute to do just that. But this doesn't reduce collective risk one jot, its just a waste of people's time and additional cost on building societies.

"only a quarter of Northern Rock's mortages were funded through cash deposits and the remainder through borrowing wholesale on the money market". So How is guaranteeing only a quarter of NR's deposits a bail out?

And "there is a good case for arguing that NR's business model wasn't that of a typical mainstream deposit-taking financial institution and that is why it ran into problems ". So why didn't regulators do what we pay them to do and take action?

And you still haven't answered the main point. The use of the word "institution" is a smoke screen. There are groups of indidivuals associated with the institution and unless you can break your theories down to a mechanism that acts on the different groups and demonmstrate how that reduces risk then its just too blunt an approach to provide effective analysis


Mark Wadsworth

What Dipper says (all comments).

Bob B

"What we currently have now is a situation where building societies are full of people moving their money around so that they have a max of £30,000 in lots of institutions."

That would be a prudent course in any event on the old adage about not putting too many eggs into one basket. But then some deposit-taking institutions have long offered higher returns on larger deposits - doubtless, partly to compensate for any additional risk under the standing deposit protection scheme.

In the event, Alistair Darling has moved swiftly overnight to rectify sins of omission and commission on the part of HMT:

" . . In an interview with The Times at the end of a week of turmoil, the Chancellor of the Exchequer disclosed that he was looking at giving Britain a US-style system of savings protection, under which deposits held in a collapsed bank would be moved into a special vehicle and paid back to savers within days.

"The scheme, paid for by a levy on banks and other financial institutions, would be one of several measures to return confidence to the system and allow the Bank of England to carry out its role as a lender of last resort."
http://www.timesonline.co.uk/tol/news/politics/article2508003.ece

Mind you, before anyone becomes over-excited at the prospect of US-style regulation and deposit protection, we might note that US-style financial regulation has done absolutely nothing to prevent the emergence of the sub-prime mortgage problem in the first place, which is precisely what is causing the present turmoil in world financial markets and which is why Northern Rock's business model came unstuck when banks became reluctant to lend to other banks for any period longer than a day at a time.

Btw according to the BBC report on this:

"Some of the planned changes to banking rules were already in the pipeline before the run on Northern Rock and would be announced when the House of Commons returns next month, Mr Darling said."
http://news.bbc.co.uk/1/hi/business/7007835.stm

That looks a tad leisurely to my way of thinking and hardly suggests that the issues had been anticipated by HMT. According to much press punditry, there is a long way to go yet before the consequences of the US sub-prime mortgage problem fully run their course.

Economists might ponder how it is that the US with so many Nobel laureates in economics manages to generate so many regulatory issues. I've already remarked on the S&L Association debacle of the early 1980s but remember also the news in 2001 about power cuts in California?

"California faces further power cuts in the summer despite desperate efforts to secure a stable supply of energy to the state.

"Power blackouts 'appear inevitable' and could also spill over into other Western states, according to President George W. Bush's administration."
http://news.bbc.co.uk/1/hi/business/1224693.stm

Dipper

the rich are permanently short an option to the masses. They have to constantly justify to the rest of society why they shouldn't have their extra wealth forcibly removed.

So far in recent times they've been successful. But when pensioners start losing their savings it makes sense for the masses to start exercising their option. I suspect that in the next few weeks we will see Darling take steps to curtail the opportunities to become rich in order to protect the wealth of the masses.

Now I've calmed down Bob yes moral hazard is real and you've reasonably pointed out many cases where it has manifested itself and could do so again, so no arguments with that.

Bob B

Saturday's news:

"Hedge funds reaped £1 billion in profits from Northern Rock’s collapsing share price over the past seven months, according to one of London’s most prominent hedge fund managers. . . "
http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article2508081.ece

"Northern Rock has been forced to borrow about £3bn from the Bank of England over the past week, it emerged on Friday in the first official estimate of the extent of its funding crisis.

"The scale of the taxpayer-funded loans were revealed as Northern Rock said it intended to press ahead with a dividend payout to shareholders even though the company had acknowledged it was not legally obliged to do so."
http://www.ft.com/cms/s/0/efbc281a-687a-11dc-b475-0000779fd2ac.html

"The biggest shareholder in Northern Rock warned on Friday that aggressive short-sellers would pick a new mortgage bank to target if the Bank of England did not maintain 'indefinite' support for the Newcastle lender."
http://www.ft.com/cms/s/0/523475d2-6872-11dc-b475-0000779fd2ac.html

Bob B

"the rich are permanently short an option to the masses. They have to constantly justify to the rest of society why they shouldn't have their extra wealth forcibly removed."

Yeah. Yeah. This quote is taken from the Independent on Sunday five years ago:

"Wealthy foreigners can look forward to several more years of using the UK as a tax haven, while Treasury officials ponder over how to implement a promise by Gordon Brown to close the loophole.

"The promise will be repeated when the Chancellor makes his pre-Budget statement in the Commons early next month, but Mr Brown will not be able to tell MPs when he might bring in the measure, which is expected to be worth an extra £1bn for the Treasury."
http://findarticles.com/p/articles/mi_qn4159/is_20021020/ai_n12669831

Those of us with longer memories can recall GB going on about closing tax loopholes in the run up to the 1997 election. We are still waiting 10 years on. I wonder why?

dsquared

[It's a no brainer but rest assured, if tax payers keep bailing out failing financial institutions even more financial institutions will fail in future and more tax payers money will be spent bailing them out too.]

Bob, you really can't just make abstract statements like this and expect them to go unchallenged. There is no need for blackboard economics here. We've had deposit insurance for fifty years. Has it resulted in more or fewer, smaller or larger bank failures? Answer, fewer and smaller.

Second question, how much taxpayers' money has currently been spent on bailing out Northern Rock. Answer to the nearest "none".

Bob B

Deposit protection (or deposit insurance) is certainly not the only factor in bank failures or, more broadly, the failure of deposit-taking institutions.

Deposit insurance protects the wealth of depositers (usually smaller depositers up to some limit) and thereby curbs the spread of crises of confidence by contagion which might otherwise lead to "bank runs". But deposit insurance by no means guarantees the absence of failures. The surge of S&L Association [1] failures in America in the late 1970s and early 1980s [2] occurred despite deposit insurance, the origins of which dated back in America to President FDR and the New Deal in the 1930s.

Some mainstream sources add with emphasis that the S&L Assoc. failures were also the predictable result of deposit insurance - because deposit insurance creates a moral hazard for the shareholders (and/or) their agents managing deposit-taking institutions as they come to appreciate that there is a prospect of achieving greater rewards by investing the deposits in higher risk assets when the downside consequences of doing so are underwritten by the state (in the S&L Assoc. case) or the finance industry at large, which is what is being proposed for Britain. The current £3bn loan from the BoE to sustain Northern Rock is underwritten by British taxpayers.

There is nothing at all novel about the notion of moral hazard. Insurance institutions were already familiar with the problem centuries before economists and it's why insurance institutions widely offer the like of no-claims bonuses or only insure losses in excess of some initial amount which has to be borne by the insured. Readers will doubtless be familar with cases where the premises of failing businesses burn down.

Any who imagine that state ownership of banks would avoid the inequities and inefficiencies of capitalism are advised to read this:
http://news.bbc.co.uk/1/hi/business/the_company_file/297004.stm

[1] "A savings and loan association is a financial institution which specializes in accepting savings deposits and making mortgage loans. The term is mainly used in the United States; similar institutions in the United Kingdom and some Commonwealth countries are called building societies. . . "
http://en.wikipedia.org/wiki/Savings_and_loan_association

[2] "The Savings and Loan crisis of the 1970s and 1980s was a wave of savings and loan association failures in the United States in which over 1,000 savings and loan institutions failed in 'the largest and costliest venture in public misfeasance, malfeasance and larceny of all time.' The ultimate cost of the crisis is estimated to have totaled around USD$150 billion, about $125 billion of which was consequently and directly subsidized by the U.S. government, which contributed to the large budget deficits of the early 1990s."
http://en.wikipedia.org/wiki/Savings_and_Loan_crisis

Bob B

What's new?

With this news report in tomorrow's Sunday Times, it seems to me that all those economists who predict that deposit protection/insurance leads on to higher risk investing are proved absolutely correct.

"Northern Rock stands accused of 'reckless' lending after it emerged this weekend that the beleaguered bank is still offering mortgages of six times salary to potential borrowers.

"Despite provoking the worst banking crisis for decades, the bank last week offered a reporter posing as a first-time buyer a £180,000 mortgage even though he had a salary of only £30,000.

"The loan was at least £30,000 more than other leading lenders were prepared to offer. Repayments for the loan would have accounted for more than 60% of the fictional buyer’s take-home salary."
http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article2512384.ece

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