Stiglitz: Britain should have let basket case banks go bust

February 4th, 2009

StiglitzProfessor Joseph Stiglitz, the Nobel prize-winning economist and author of Globalization and its Discontents, has said that the UK would should let its failed banks go bust rather than continue to throw good money after bad.

Stiglitz believes it would be far better for all concerned if the life support at dysfunctional banks such as RBS was switched off, and they defaulted on their massive overseas obligations and retrenched back to the UK market. He said:

“The UK has been hit hard because the banks took on enormously large liabilities in foreign currencies. Should the British taxpayers have to lower their standard of living for 20 years to pay off mistakes that benefited a small elite? There is an argument for letting the banks go bust. It may cause turmoil but it will be a cheaper way to deal with this in the end. The British Parliament never offered a blanket guarantee for all liabilities and derivative positions of these banks.”

This need not — contrary to all the spin from bankers and their apologists — cause financial mayhem at home. Stiglitz pointed out that the government of prime minister Gordon Brown could underwrite all the bank’s domestic deposits in order to protect the UK’s financial system and safeguard its money markets. He believes the government could then use the skeletons of RBS and other failed and defunct banks as the starting point for a healthier and more sustainable structure.

“The new banks will be more credible once they no longer have these liabilities on their back.”

In an interview with the Daily Telegraph, Stiglitz said that the City of London would be able to survive the shock of such a default as, in his view, it would uphold the principle of free-market responsibility. “Counterparties entered into voluntary agreements with the banks and they must accept the consequences.” There are clearly plenty of difficulties and risks. One is that the proposal could hurt “private sector” banks such as HSBC, which would have to compete in the market for funds with copper-bottomed state-run entities.

Stiglitz also proposed a “Chapter 11” scheme for households to allow them to bring their debts under control without having to declare themselves bankrupt. “Families matter just as much as firms. The US government can borrow at 1% so why can’t it lend directly to poor people for mortgages at 4%. ,” he said. Stiglitz’s proposal got an enthusiastic response from some contributors to the Citywire website. One (M. Porter – Failed Banks) said:

“The great advantage would be that, in one fell swoop, this would clear out layers of cost relating to the irrelevant, failed side of the business – i.e. proprietary trading, structured assets, investment banking etc. The remaining banks would easily soak up the remaining (valid) aspects of normal high-street banking services …  All that expensive and unnecessary real estate would go.”

The UK learnt a painful lesson in the 1970s and 1980s, which is that there is nothing to be gained — and much to be lost — by propping up lame duck industries which persist in trying to sell redundant products. Why haven’t we learnt from that experience? (See my article: Can politicians really make banking leopards change their spots, 12th October 2008).

Trust is not going to return to the market until such time as all the bad news comes out, and the pain has been felt, at which point the banks might conceivably rediscover the confidence they need to start lending again. For this to happen they also need to properly apply Pillar Two of Basel II and invest in the technological and human resources needed to conduct a proper economic capital modelling assessment of their business — rather than persisting with the hopelessly demoded accountancy methodologies and silo-like structures still being used.

The bailouts have rewarded banks that behaved recklessly and even criminally, but punished those that behaved prudently.  Gordon Brown’s economic illiteracy blinds him to such truths. The prime minister is blind to the fact that, without the Minsky-esque “creative destruction” aspect of capitalism, we are condemning ourselves to repeat the errors of the past and probably a Japan-style lost decade.

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2 Comments for “Stiglitz: Britain should have let basket case banks go bust”

  1. […] like the Nobel-prize winning economist Joseph Stiglitz, Rogers believes that allowing failed banks to go to the wall would have been better for all […]

  2. […] like the Nobel-prize winning economist Joseph Stiglitz, Rogers believes that allowing failed banks to go to the wall would have been far healthier in the […]

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