When the credit crunch hit in 2008, governments around the world turned to the one set of people who, by definition, couldn’t give them disinterested advice, namely bankers. Predictably enough, the bankers solemnly assured the ministers that, unless they received colossal sums, the entire economy would collapse. I’m sure that if governments contracted out their policy on subsidising bakeries to bakers, they would also be told that handouts were vital. The bakers might even half-believe it themselves. But they would be wrong, just as the bankers were wrong. Proof of just how wrong can be found in Iceland, which was in no position to assume private bank liabilities, and which consequently – despite being far worse hit by the collapse than any EU state – is now in healthier shape than many eurozone countries. Don’t take my word for it: even Paul Krugman, guru to statists and Keynesians everywhere, has noticed.Krugman's words are worth repeating:
He's wrong that countries should debase their currency, but he's right that banking losses should have stayed private.
The credit default swap (CDS) for the Icelandic state has now dropped to 200 points and has not been lower since many months before the banking collapse in October 2008. The CDS has been in constant decline since January and indicates growing faith in Iceland’s economy.
Meanwhile, the CDS spread for Ireland is 683 basis points.
Why, it’s almost as if defaulting on debts run up by runaway bankers and letting your currency depreciate works better — even from the point of view of investors — than socializing private-sector losses and grimly sticking with a fixed exchange rate.
I wish that Norman Tebbit could see this. In his latest article, he wrote:
I thought I should start by answering reagus, who asked what I would have done had I been drafted in to take charge as the financial crisis struck. I am sure that I would have supported the banks. Had they failed, the consequences would have been too awful. But I would have wanted the directors of several of them to be charged with false accounting in that they published accounts they must have known, or ought to have known, were not a true and fair picture of their banks affairs. Not only that, I would have tried to go for the auditors too, not as firms, but as individuals. The sight of those men in the dock at the Old Bailey would have done more good than a truckload of new regulations.Tebbit's heavy-handed approach is unrealistic. Prosecuting a handful of individuals who crossed the line from recklessness to fraud would do nothing to discourage a future banking crisis. I replied as follows:
Personally, I think the consequences of letting the banks go bust have been greatly exaggerated. Could you elaborate on what terrible consequences you would have expected, and why they would have been worse than the situation we currently face?What I'm saying here sounds to me like common sense, but it's clearly not all that common.
From my perspective, bailing out the banks was the greatest of Gordon Brown's many mistakes. He socialised losses that should have been private. Such behaviour is inexcusable whether you claim to support the free market (as most Thatcherites do) or the working man (as most Labour politicians do).
I think the failure of retail banks could have been managed through the usual orderly process that kicks in whenever a business goes bankrupt, but any emergency measures that may have been necessary should have ensured that shareholders in the banks were wiped out.
Banks behaved recklessly with the expectation that they were considered too big to fail, and their gamble paid off. Now the moral hazard has only increased.