Why shouldn’t we let the bankrupt go bust?

A genuine question, and I’m trying to work out the answer (so here I’m thinking out loud).

If Greece defaults – which looks very likely very soon – then there are banks which have made loans to the Greek government which will then not have those loans repaid. This is on such a scale that it is likely that many banks would themselves become insolvent. There is thus great pressure on governments to ensure either that Greece does not default (they’ve lost that one) or, if it does, that the banks are ‘ring fenced’ from the consequences of their actions.

This doesn’t seem right to me.

Assuming Greece defaults (or the other PIIGS) why shouldn’t we let the banks go bust in consequence? After all, it is their decision making which such a fault would put to the test. What would be the malign consequences?

Well, for the ‘average person’ probably not very much. In the UK – and I guess elsewhere – there is deposit insurance, which means that most people’s bank accounts are protected. If one bank goes bust then their customer base is an asset which is then sold on by the auditors who are trying to maximise the asset value from the bankruptcy proceedings. So that side of things is covered.

Those who are richer will get a more or less severe financial haircut, in several ways. Firstly, there is a threshold to the deposit insurance, so deposits above that level would be lost. Second, those who have shareholdings in the bank will – largely – see that investment be destroyed. Thirdly, those who have pensions may be at risk of seeing those pensions lose value if those funds are invested in insolvent institutions.

The thing is, those latter malign consequences I do not see as being anybody else’s business. That is the nature of the free market. If you invest in a company that makes bad decisions then you will likely lose your money. What I most object to is a systemic bias towards privatising gains whilst socialising losses. Or, to put that more simply, I believe that it is shockingly immoral for general taxation to be used to subsidise incompetence and greed. To use an admirable politician’s latest catchphrase, this is simply crony capitalism, and it is corrupt.

At this point the spectre of ‘systemic risk’ is raised. If we don’t stop the banks going bust then civilisation will collapse – I paraphrase, but that is normally the gist. Civilisation is collapsing anyway – and not least because we have ignored the moral foundations of our communities and societies. My view, therefore, is that destroying the notion of moral hazard, making the rich invulnerable to the consequences of their own misjudgements, is part of the problem, not part of the solution.

So I say – let the bankrupt go bust. If we no longer bail out the venal and the incompetent then perhaps there will be a little bit of money left over to look after those in genuine need.

Make sense?

6 thoughts on “Why shouldn’t we let the bankrupt go bust?

  1. I agree that this is a better option than all attempts at “saving” the Greek economy, but it seems to me there is an even better option – that Greece simply decides not to pay their debts. It would have more or less the same effects as those you describe, with the benefit that it would probably be softer on the people living in Greece, since this would not involve a shut down of the Greek state.

  2. We are currently looking at similar issues with much of the privatised social care. Care homes were sold to private businesses who creamed off massive profits. Now that they are no longer profitable the private companies are shutting them down.

    There is a vast outcry. “oh no, how can they do this to us? Aren’t they being evil. My dad was in that home…”

    Nope. “we” set up the rules to be insentivised by financial gain for the rich instead of social care for the elderly. They are following the rules society has set.

    They are stupid rules.

    Since the early 80’s we’ve been living with the view that you can have somethig for nothing. Pushing beans from one pot to another and saying that there’s more beans in the pot now doesn’t make a very tasty casserole.

  3. I suspect that most of us have money invested in these banks, directly or indirectly, through pension funds. If the banks fail then generally older people will lose more.
    If the banks are bailed out, by printing more money, then the value of money is devalued and everyone loses out more or less equally.
    This is independent of the issue of bankers’ rewards. If the banks are bailed out by taxpayers, in principle we have the option of limiting what bankers pay themselves. In practice those in power seem reluctant to use this sanction.
    Personally, being near retirement age, I would favour the taxpayer funded bailout. However, thinking of my children and society generally then letting them fail would be the better solution.

  4. Banks only have a small percentage of money in cash form. Most of our savings are used as capital for further loans or investments. When banks go bust, there isn’t enough physical cash to cover the withdrawals and other banks are only interested in the ‘good’ loans. Deposit insurance isn’t worth the paper it’s written on.

    That’s why ‘trust’ or ‘confidence’ is so important in economics . The money in your pocket is a debt: someone owes you X goods and services. The engine of growth is creating money through interest rates and investments. That money is not anchored anything more than trust.

  5. It’s what was learned after Lehmann went bust – where the logic at the time seemed to be that a lesson should be meted out to these irresponsible banks. Given the apparent consequences, policy makers are reluctant to try that one again. The whole financial system seems to depend on the vast web of interbank lending. This, as theObserver points out, relies heavily on trust. One bank lends overnight to another (on the repo market) and has to be confident that the collateral it gets — longer term assets — is going to be sufficient in case there is a problem getting its money back. Once there is doubt about that, say if the collateral involves claims on other banks, the required collateral goes up, but there isn’t enough of the stuff around to maintain the previous levels of interbank lending. This multiplies through the system and the total amount of money washing round contracts, possibly disastrously. This is what seemed to have happened at the height of the crisis. The end result is that banks cannot extend credit to the real economy, with the consequences which we have seen.

  6. Amen. Let them go bust. And at the same time, take another look at the idea of having pensions all invested in the stock market and the kind of moral hazard associated with having large segments of the population feeling indebted to protecting the speculators and risk-takers (see Anon’s very honest post above).

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