Simon Johnson on the problem :
8) If any country provides unlimited government support for its financial system, while not implementing orderly bankruptcy-type procedures for insolvent large institutions, and refusing to take on serious governance reform and downsizing for major troubled banks, it would be castigated by the United States and come under pressure from the IMF. Yet this is the approach that the U.S. has implemented.
9) At the heart of every crisis is a political problem – powerful people, and the firms they control, have gotten out of hand. Unless this is dealt with as part of the stabilization program, all the government has done is provide an unconditional bailout. That may be consistent with a short-term recovery, but it creates major problems for the sustainability of the recovery and for the medium-term. Again, this is the problem in the U.S. looking forward.
10) The Obama administration argues that its regulatory reforms will rein in the financial sector in this regard. Very few outside observers – other than at the largest banks – find this convincing.
towards a solution:
10) Today our politicians and regulators lack credibility. They have bailed out too many banks and need to show they have truly regained the upper hand — by showing that they are installing such a hard size cap rule without exception.
11) The litmus test is simple. Does Goldman Sachs continue to grow, and continue to be regarded as almost as good a risk as the United States government (Goldman’s Credit Default Swap spread is currently around only 70 basis points above that of the United States), because it has demonstrated it is too big to fail? Or, will the government impose a cap on the size of such institutions and require Goldman Sachs to find sensible ways to break itself into pieces – becoming small enough so that it will not be bailed out again next time?
and in the absence of real reform:
1) Real progress towards reducing the risks inherent in the U.S. financial system is unlikely. As long as there are financial institutions that are Too Big To Fail, we face a potential fiscal cost. We should recognize this in our government budget and balance sheet accounting.
2) The overriding principle behind IMF fiscal assessments is the need to capture true total fiscal costs. Best practice for the U.S. needs to reflect this approach.
3) All subsidies and taxation – including the entire cost of supporting the continued existence of large banks – should be reflected transparently in the budget and subjected to the prioritization of the budgetary process.
4) Our current accounting for guarantees and governments’ assumption of other contingent liabilities create the impression that government actions to support the banking system are costless. This is a dangerous illusion – as seen in the recent increase in US federal government deficit and debt.
5) If we don’t recognize these costs explicitly, we run the risk of taking on ever more contingent liability. If the financial system reaches the point where its failure cannot be offset by fiscal (and monetary) stimulus, then a Second Great Depression threatens.
6) Next time, we cannot be certain that the available size of fiscal stimulus – either in the US or worldwide – will match the negative shock to demand caused by the credit crisis. Either we will already have too much debt or we will be constrained by the consequences of taking on even more debt. Or – just as in 1930 – the financial decelerator will simply be too large to be offset by any feasible fiscal measures.
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