Do government bailouts in times of banking crises work? Philippa Dunne & Doug Henwood of The Liscio Report highlight a major study of 42 fairly recent banking crises around the world. Result? Some types of government intervention works and some don't. One characteristic that is needed though is speed. Dithering, a la Japan, is a recipe for disaster. This is a brief summary of the report (to which they provide a link) and their conclusions as to the basic outlines of what the US should do. Given that Europe is already in the throws of its own bank crisis, and the rest of the world could experience problems, this should be useful reading. They also provide graphs of banking crises and comparisons with developed countries and the resulting market experience.
One major point? This is like the old Fram oil filter commercial line "Pay me now or pay me later." As this study points out, the tax payers and citizens of the US (and the world) are going to pay for this crisis in one way or another. Either a major recession (with high and persistent unemployment), reduced incomes and tax collections or a collective efforts to stabilize the banking system. The costs of inaction are much higher. It is not a matter of cost or no cost. We are going to have to pay in one form or another.
We cannot avoid the costs given where we are today. The time to avoid cost was years ago reigning in Freddie and Fannie and proper oversight of the mortgage industry. We (Congress) missed that opportunity. (Sadly, we are going to re-elect the very leadership to both parties largely responsible for the neglect. There is plenty of blame to go around. No amount of partisan finger pointing by Speaker Pelosi shifts that blame.) However, we can choose the form of the cost will be paid in. Personally, I prefer collective efforts to 10% or more unemployment and the risk of an extended recession and its costs. I know this is not pure free market theory, and sticks in the craw of many of my readers, but when many of my neighbors and friends will be unemployed and businesses are suffering theory will not make a very good meal. Congress must act now. This report is a good reminder of what has worked in the past.
My thanks to Philippa and Doug for allowing me to send this as a Special Outside the Box. You can see their work and blog at http://www.theliscioreport.com.
The purpose of Outside the Box is to present views which cause us to think through our basic assumptions. This week our old friend Michael Lewitt of Hegemony Capital Management gives us a view as to why the bailout bill going down may not be as bad as I think it might. There is much we agree on, however. And part of our agreement is that a deeper recession is in our future. Let me be clear. Muddle Through is now at risk.
I have talked with my publisher, and for the next few weeks of The continuing Crisis, we are going to send more than one OTB per week, and I may also add some short commentary. These are extraordinary times, and I know a lot of you (as I can tell from phone and emails) are worried and are interested in analysis that is not biased with either a perma-bull or perma-bear stance. I will call it as I see it, as always, and forward you material from my best sources.
That being said, we will get through this, one way or another. Sanity and clarity will return, as it always does after times of crisis. I wish you the best in your situation.
This week we will look at what will be a fairly controversial essay by good friend Michael Lewitt of HCM. In light of today's speech by Treasury Secretary Henry Paulson of the re-organization of the regulatory system in the US, Michael suggest we look at what the real problems are before we begin the process of re-arranging the deck chairs on the Titanic. For many, some of what he says will be considered economic heresy. I do not agree with all of it (though I am in solid agreement on most of it), and look forward to talking with him in a few weeks in La Jolla when we are together. But the point of Outside the Box is not to find material that I or you agree with or that makes us comfortable, but something which causes us to think through our own opinions and biases.
But this is a debate that absolutely must happen if we are to move forward and away from the current crisis and to somehow see if we can avoid yet another crisis in five years. Simply adding new regulations without changing the incentive nature of the markets will not fix the things that really matter. None of us should cry when some fund that is leveraged 30 to 1 goes down and investors get wiped out. What were they thinking anyway? But when a fund or investment bank is so big that its demise threatens the system that we participate in, something is wrong in the way our society manages risk. Simply bailing out big banks is not an adequate regulatory response. While it may work for the immediate moment, it does not solve the longer term issues.
Please feel free to forward this letter to anyone you think should be part of that debate process.