BAILOUT BS: End “moral hazard” with haircuts for banks!

Europe’s experiment with a unified currency has fallen victim to duplicity, cupidity & stupidity. Political ideologues purposefully looked the other way when Greece winked & nodded its way into the euro-zone as part of a scheme to protect & project the European welfare state.

Similarly, member countries were allowed to ignore fiscal probity required by the Stabilization Pact as public-sector debt-to-GDP ratios rose beyond limits required under that treaty.

Now, private banks that systemically engaged in risky bets on sovereign bonds to earn high yields find such deals going sour. In turn, they demand bailouts to contain “contagion” lest other banks fall like dominos.

But banks suffering from ill-advised investing are not innocent victims exposed to a random contagious disorder. Their problems are completely self-inflicted, and problems associated with weakened banks should not be considered contagion, per se.

When investors ignore potential problems with repayment of sovereign bonds, it is because of “moral hazard” created by governments guaranteeing that debt. In the US, such guarantees exist for mortgages and student loans as well as implicit promises to repay debt on state and local governments. With such guarantees are off budget, investors & credit-rating agencies tend to overlook it.

For their part, bank regulators must remove perceptions that sovereign debt is risk-free. In turn, banks ought to hold sufficient capital against losses on sovereign loans or have insurance (e.g., credit default swaps) against their sovereign holdings.

While banks should be held responsible for their own mistakes, taxpayers & voters ought rightly blame regulators & politicians for bad policy choices.

But since the only way to learn from a mistake is to bear the costs of doing so, banks & other investors in sovereign debts must accept the “haircuts” warranted under current conditions.

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About christopher

Content of "Natural Order" attempts to reflect the commitment of Universidad Francisco Marroquin to support the development of a society of free & responsible individuals. The principal commentator for this blog is Christopher Lingle.

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