Monday, September 22, 2008

Behind the motives of The Bail-Out

Authors of the book of Too Big To Fail: The Hazards of Bank Bailouts (2004) - Gary H. Stern, Ron J. Feldman of the Federal Reserve Bank of Minneapolis had this to say -
Many of the existing pledges and policies meant to convince creditors that they will bear market losses when large banks fail are not credible and therefore are ineffective. Blanket pledges not to bail out creditors are not credible because they do not address the factors that motivate policymakers to protect uninsured bank creditors in the first place. The primary reason why policymakers bail out creditors of large banks is to reduce the chance that the failure of a large bank in which creditors take large losses will lead other banks to fail or capital markets to cease working efficiently. Other factors may also motivate governments to protect uninsured creditors at large banks. Policymakers may provide protection because doing so benefits them personally, by advancing their career, for example. Incompetent central planning may also drive some bailouts.

For the history of bank bail-outs in the US, read here.

Do we see the return of the ‘essentiality doctrine’ of the 1980s? Authorities then forged a criteria to deal with various bank failures. The doctrine was also an explanation to the public on why the government was doing what it was doing. It feels strange now that officials then were overwhelmed by "lightening-fast removal of large deposits from around the world by electronic transfer."

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