Larry Summers has a mistitled as well as horrendously flawed op-ed in the Financial Timed on How to save the eurozone.
A more appropriate title would be “How to save the rich”. Please consider a few galling snips.
US policymakers were applauded for about 12 hours for their willingness to let Lehman go bankrupt. The adverse consequences of the shattering effect that had on confidence are still being felt now. The European Central Bank is right in its concern that punishing creditors for the sake of teaching lessons or building political support is reckless in a system that depends on confidence.
No one wants to punish creditors simply for the “sake of teaching lessons” but rather to prevent moral hazards that accompany bailouts. The simple fact of the matter is that in a capitalistic system, money will be misappropriated unless failure is allowed.
A few economic bloggers like me applauded, but Bernanke called it his biggest failure. I think the collapse of Lehman is about the only thing Bernanke did right.
Banks acted recklessly because they thought they would be bailed out, and they were.
Those who let Lehman go believed that because time had passed since the Bear Stearns’ bail-out, the market had learnt lessons and so was prepared. In fact, the main lessons learnt were on how best to find the exits, and so uncontrolled bankruptcies had systemic consequences that far exceeded their expectations.
The main lesson is that bubbles burst and it is best to prevent bubbles not blow them, unless of course there is a guarantee that reckless behavior will be bailed out.
On such a guarantee, the proper course of action for any “too big to fail” organization is to blow as big a bubble as humanly possible.
Now let’s consider Larry Summers’ solutions.
First, for programme countries, interest rates on debt to the official sector should be reduced to a European borrowing rate, defined as the rate at which common European entitities backed with joint and several liability by all the countries of Europe can borrow. A default to the official sector will not be tolerated, so there is no reason to charge a needless risk premium that puts the whole enterprise at risk.
With that set of statements, Larry Summers just embraced the European Nanny State solution.
Second, countries whose borrowing rate exceeds some threshold – perhaps 200 basis points over the lowest national borrowing rate in the euro system – should be exempted from contributing to bail-out funds. The last thing the marginal need is to be pulled down by the weak.
Why should any country in the Eurozone be forced to bail out any other country? Bear in mind it is taxpayers bailing out the sovereign debt of other nations.
Third, there must be a clear commitment that, whatever else happens, no big financial institution in any country will be allowed to fail. The most serious financial breakdowns – in Indonesia in 1997, Russia in 1998, and the US in 2008 – came when authorities allowed doubt over the basic functioning of the financial system. This responsibility should rest with the ECB, with the requisite political support.
This proposal of Larry Summers is pure idiocy at its finest. As stated above in a capitalistic system, money will be misappropriated unless failure is allowed. What would a bailout guarantee do other than promote more reckless behavior?
Fourth, countries judged to be pursuing sound policies will be permitted to buy EU guarantees on new debt issuances at a reasonable price, payable on a deferred basis.
Once again I ask, Why should taxpayers in any country be forced to bail out any other country?
It is hard to find so much gall, arrogance, and stupidity in one place as in that article. I picked the post up from Arthur Fullerton who wrote Only Poor People Can Be Allowed to Fail
Trying to create a world financial system where “no big financial institution in any country will be allowed to fail” is an unsustainable act of hubris and is itself doomed to failure.
Precisely, and for the exact reasons I stated.
Mike “Mish” Shedlock
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