Eurointelligence today carries an interesting news report
Sweden proposes stability tax
The Swedish finance minister Anders Borgh has written to his EU colleagues in favour a stability tax levied on banks who proceeds could be used for future bail-outs. Sweden has already imposed a tax of 0.0036% of bank liabilities. FT Deutschland points out that this is not a Tobin tax on bank transactions. Sweden has introduced this tax this year, and expects the revenue from this tax to grow to 2.5% of GDP in fifteen years.
Such a ‘rainy day’ fund would have been helpful during the current crisis (although there is a classic moral hazard counter-argument). Indeed, I had previously suggested the establishment of such a fund as part of Ireland’s preparations for EMU membership, given the fiscal costs that accrue in the event of banking crisis. My contribution can be downloaded here. The difference is that the Swedish fund is financed by a tax on the banking sector, whereas I had in mind a fund to be accumulated from general tax revenues.
18 replies on “Pre Funding Future Bank Crises”
Where would all this rainy day money be kept while we waited for the storm? Would it create another credit bubble much as the Asian savings glut is said to have done?
Presumably, all these assets would need to be held in Sovereign bonds. And then not just any sovereign bonds.
While in Ireland we might hink a rainy day fund consisting of Bunds might make some sense, Germans might wonder why they are being taxed, simply to lend to their own government.
The ‘investment’ could just as readily be (have been!0 a run-down of outstanding debt to zero.
The Irish government will have a considerable amount of its resources tied up in NAMA, so perhaps a bank crisis contingency fund would make sense over the coming years. I don’t have to imagine very hard to know how NAMA is going to turn out, I have seen this movie before. I know the basic plot.
I predict we will see photos in the newspapers in the next couple of years of Brian Lenehan and pals swaggering up and down the footpaths to the High Court in much the same manner as we saw David Torpey and John Pope this summer.
Zoe developments was like a small version of NAMA in itself. €3.0 billion out standing in credit flows and another couple of billion worth in property titles. That is an asset management vehicle in anything except the name. It doesn’t matter really who is ‘driving the bus’, it still works out the same, and in the end, the ending is the same.
These ‘vehicles’ of this size are impossible to steer – even if you can see the lamp post looming up in your wind screen view – by the time you steer away it is probably too late.
What is surprising and probably non-intuitive is given the size of a company like Zoe as far as financial volumes go, it was one of the leanest in terms of its staff. It was like driving a huge big heavy bus, that is hard to steer and has very few passengers on it.
Like NAMA asset management vehicle today, everyone I knew had an opinion about Zoe developments. When I offered any of those people a job to work at Zoe, because they were so willing to offer their opinions, they would always decline politely and back away.
It is a bit like asking someone to paint your walls in your house, because they have so much to say about the colour. But then they decline politely and offer instead, to do some flower arranging instead.
It was funny that, a large property company which found it difficult to hire. Everyone out there knows that the bus is too large and is going to crash at some stage, so they do not want to become a passenger.
You see, nobody really wants to work for the large institution because it is so vulnerable to spectacular failures. On the other hand, everyone in such a small country has a strong opinion.
I think the trouble with AIB bank is that everyone has pre-judged it as so risky a vehicle to drive, on a treacherous road ahead, that people expect a huge ‘risk premium’ to consider working there, because their career might be so short.
It is an ironic thing that, a smaller, more nimble financial vehicle – like that the ex. Bank of Scotland Ireland chief has set up – is a better option in terms of attracting management talent and funding to do its job.
I need to think about this some more, but those are a couple of thoughts to leave you with.
TBH – the idea of a crisis fund mitigates the “Never Again” credo which we should be espousing.
Martin Wolf in the FT on that point of view:
@Zhou re .. “Never Again”
Since one of the reasons we had to prop up the financial institutions was because they were considered “too big to fail” and a collapse of one was theoretically going to lead to a collapse of them all in a domino effect. If they are too big to fail the logical thing would seem to me to chop them into smaller institutions, and limit their sizes so that none of them will ever again be too big to fail. Is that outlandish?
there needs to be a bigger discussion about what we want the banking system to look like in say 5 yrs or so in terms of what banks are offering what services, how much of the banking sector is controlled by irish domiciled banks vs foreign ones, how big any bank should be in any given market given the ‘too big to fail’ issues.
ILP + EBS + INBS as a mortgage and savings bank, but only up to a maximum level in terms of mortgages (both % of market (say 25%) and actual nominal values, ie €750k)
AIB/BOI offering some big and small mortgages but with a cap on market share (say 10-15%), business banking, wealth management, small level corporate, maybe a ban on construction related, sell off asset management, custodial services etc
Re-loaded Anglo being an SME business lender
Foreign banks servicing SME, commerical and institutional, construction etc
These questions need to be asked now and a basic framework put together by various parties over the next 12 months so that when the recovery comes and normality eventually returns, we know where we are going and what we want to do.
you’re in good company – Mervyn King has been saying the same thing:
from David Einhorn, the guy who called Lehman’s almost bang on correct last year:
“With the ensuing government bailout, we have now institutionalized the idea of too-big-to-fail and insulated investors from risk.
The proper way to deal with too-big-to-fail, or too inter-connected to fail, is to make sure that no institution is too big or inter-connected to fail. The test ought to be that no institution should ever be of individual importance such that if we were faced with its demise the government would be forced to intervene. The real solution is to break up anything that fails that test.
The lesson of Lehman should not be that the government should have prevented its failure. The lesson of Lehman should be that Lehman should not have existed at a scale that allowed it to jeopardize the financial system. And the same logic applies to AIG, Fannie, Freddie, Bear Stearns, Citigroup and a couple dozen others.
Twenty-five years ago the government dismantled AT&T. Its break-up set forth decades of unbelievable progress in that industry. We can do that again here in the financial sector and we would achieve very positive social benefit with no cost that anyone can seem to explain.
The proposed reform takes us in the polar opposite direction. The cop-out response from Washington is that it isn’t “practical.” Our leaders are so influenced by the banking special interests that they would rather declare it “impractical” than roll up their sleeves and figure out how to get the job done.
The bailouts have installed a great deal of moral hazard, which in the absence of radical change will be reinforced and thereby grant every big institution a permanent “implicit” government backstop. This creates an enormous ongoing subsidy for the too-bigto-fails, as well as making it much harder for the non-too-big-to-fails to compete. In effect, we all continue to subsidize the big banks even though we keep hearing the worst of the crisis is behind us.”
I find the “moral hazard” argument to be unconvincing – unless you look askance at any form of caution or “rainy day” planning. Is there a “moral hazard” argument against house insurance (people may set fire to their own houses in order to collect on the insurance) or even life insurance (people may fake their own death – with or without kayak – or that of a no longer so loved loved-one) ?
It seems that there is some equivalence between regulatory reform that requires higher capital reserves and ratios, and this form of taxation and reserve fund. The difference possibly is that this results in a collective reserve, whereas the other results in “insurance” at the level of individual institutions. Given that the prevailing wisdom on “systemic” failures is that it requires collective responsibility and rescue perhaps that points to this being a superior mechanism.
@ Aidan @Aedin
According to the NYT, former Fed chairmen Paul Volcker (http://www.nytimes.com/2009/10/21/business/21volcker.html?scp=2&sq=volcker&st=cse) and Alan Greenspan (http://dealbook.blogs.nytimes.com/2009/10/15/greenspan-break-up-banks-too-big-to-fail/) are also in your “good company”. Whether you find their company convivial or not, I can’t guess!
Greenspan’s comment in particular is worth pasting:
“If they’re too big to fail, they’re too big,” Mr. Greenspan said. “In 1911 we broke up Standard Oil — so what happened? The individual parts became more valuable than the whole. Maybe that’s what we need to do.”
Actually the hyper-efficient Council on Foreign Relations website has audio, video and a transcript of Greenspan’s talk:http://www.cfr.org/publication/20417/c_peter_mccolough_series_on_international_economics.html.
And scanning the transcript I notice that he fairly directly addressed the original topic of this thread:
“I don’t think merely raising the fees or capital on large institutions or taxing them is enough. I think that they’ll absorb that; they’ll work with it; and they will still be inefficient; and they’ll still be using the savings.” (i.e. the savings from the implicit “too big to fail” government subsidy.)
The old signs are probably still in AIBs basements
“1966: Provincial, Royal, and Munster Leinster merge to form Allied Irish Banks”
Not sure the “Royal” would go down well though – maybe “Imperial”
I see where you are going with your points about ‘inter-connect-ed-ness’.
But you should really check out what Hernando De Soto has had to say recently about the entire mess.
De Soto takes your point basically, but puts it through a different lense.
One telling comment from De Soto was the fact that he is seeing the same problems cropping up in the western economies now, as it has been dealing with in third world economies for quite a while.
Basically, whatever it was that gave the larger western economies their advantage over the last century and half has began to break down suddenly.
When De Soto was in the White House in the US, and the government changed its plan from using money to buy out bad assets – to pumping money into the economy in the form of some stimulus strategy – the reason mentioned for doing this was, the White US financial team couldn’t find the bad assets.
De Soto explained the difference between police in Peru and police in Miama Vice, or any other cop show on American TV. In American TV cops and robbers shows, all there is really, is a sequence by which the cops follow one physical address to another, until they sort out the crime and figure out what happened. That is the basic story.
In Peru on the other hand, you need a police person on every corner. The reason being, there is no proper legal title or records of anything, so the only way to impose law and order is to monitor people visually all of the time. Of course, the state cannot pay such a cost in the third world, so the next best thing is a kind of community based police force, or a local gang in other words.
The point is, and I think it is a good point, it speaks volumes about Anglo Irish bank and the trouble in the Gardai performing any investigation – is that in the western world, we cannot even find the bad assets anymore, and no one knows who owns what anymore. That was the legal basis for capitalism in the first world and it is broken now.
De Soto gave the example, if the house next store to you had some question mark over it, in terms of its ownership, then its value plummets automatically. Nobody will want to buy it. Nothing has changed with the house, it may be no different from your own house. But in some strange way, it is different, because it is in some legal limbo land.
I honestly don’t know what will happen with landbanks owned by the likes of Zoe and so forth. The system of legal title and charges and committments is so complicated at this stage, it may be years before we get anything sorted out. Minister Brian Lenehan is off doing something with risk analysis and what not, hiring a team. In my opinion, it is a legal team that should form the backbone of the NAMA strategy, so that we can decide upon a legal basis for everything going forward.
You all saw in the newspapers today, just how tricky it could get even between Treasury and Crosbie. Although Barrett was very quick to sort things out, before they got out of hand. Smart fellow.
Pre-funding against an event caused by state regulated bodies?
Are we serious?
Another insurance system against an event which the funders can completely control.
Just get a government that works.
“I find the “moral hazard” argument to be unconvincing – unless you look askance at any form of caution or “rainy day” planning. Is there a “moral hazard” argument against house insurance (people may set fire to their own houses in order to collect on the insurance) ”
Isn’t that exactly what is meant by moral hazard and a good argument against insurance schemes in general. You will be a good deal more careful with your chip pan or locking your bike if you know there is no insurance to fall back on.
As for the company of Alan Greenspan and Paul Volcker – I think I might be slightly out of my depth there. I do like that comment of Grenspans though. I suppose there is nothing new about that suggestion anyway.
Just to add that there seems to be a vigorous discussion of these issues – and legislative proposals – in the US at the moment.
Robert Reich, former Labor Secretary, and currently UCB Professor, has an interesting post here http://robertreich.blogspot.com/2009/10/too-big-to-fail-why-big-banks-should-be.html. He quotes the Greenspan comment I included earlier, though noting that Greenspan was a principal instigator of the repeal of Glass-Steagal. That he sees as the primary cause of the whole crisis.
Another advocate of similar positions is Sheila Bair, head of the FDIC. see for example http://dealbook.blogs.nytimes.com/2009/10/05/too-big-to-fail-must-end-for-all-fdic-chief-says/?scp=8&sq=sheila%20bair&st=cse
She seems to favour (favor?) something like the Swedish proposal, that started this thread:
“A prefunded Financial Company Resolution Fund has significant advantages over an ex-post-funded system,” Ms. Bair said. “It allows all large firms to pay risk-based assessments into the Financial Company Resolution Fund, not just the survivors after any resolution, and it avoids the pro-cyclical nature of requiring repayment after a systemic crisis.”
I find it surprising that there seems no discussion on these lines in Ireland at all – rather the intent seems to be to attempt to preserve the “bigness” of the major banks, and even to force mergers e.g. of EBS and Permanent TSB.
Reich includes a nice illutsrative description of the “moral hazard” issue implicit in the “too big to fail” situtaion also.
“The biggest difference between now and last October is these biggies didn’t know then that they were too big to fail and the government would bail them out if they got into trouble. Now they do. And like a giant, gawking adolescent who’s just discovered he can crash the Lexus convertible his rich dad gave him and the next morning have a new one waiting in his driveway courtesy of a dad who can’t say no, the biggies will drive even faster now, taking even bigger risks”
Although I would argue that these institutions did “know” then they were too big to fail, and were genuinely shocked that Lehman was allowed to go. Now they probably feel more comfortable in the knowledge that the weak, remorseful “dad” won’t let another Lehman Brothers happen.
I don’t see Sheila Bairs comment on prefunding on that link but on “prefunding” I think the only difference as regards moral hazard is the amount of certainty involved. I would see the breaking up of the institutions and “pre-funding” as two distinct approaches. Breaking up the institutions would simply remove the moral hazard and thereby the need for prefunding.
I agree about the Irish situation although now FG are making noises in the direction of breaking up the institutions.
I suppose that the fact of moral hazard is the rationale for the regulators existence is the
Oops – last line slipped in by accident