“The power to tax [and I would add the phrase ‘the power to regulate,’ or rather ‘guess-ulate’] is the power to destroy.” – Daniel Webster
There have been 553 bank failures in the US since the year 2000. Credit Suisse Group AG, a banking house founded in 1856 that built itself up to become a financial powerhouse of worldwide reach, influence and significance, is among those in trouble.
You would be mistaken if you thought the Chinese socialist system protects them from capitalistic financial crises. China has found it necessary for its central government to bail out, with many trillions of yuan, subsidiary governments and other Chinese financial entities.
I use the word “swaps” to refer to this process. I use the word in both its technical meaning as a special kind of highly capitalistic financial document, and also as a generic term to indicate the general obligations taken over by the Chinese senior government from junior entities.
These made it liable to a web of other financial entities, in some cases international lenders, since the local junior borrowers cannot pay, or at least cannot pay the now increased interest, carrier costs or renewal demands, that, absent a bailout, will drive them into a most capitalistic state of bankruptcy.
That means nobody will lend them money and everybody will demand that the weak borrowers pay up or go bust, taking with them many innocent depositors, investors, capital-needy businesses and a whole host of ordinary economic citizens whose general operations are dependent on the financial web that is needed by socialists and capitalist alike.
The bailouts (a form of re-regulation) have been made neceaary by recent guess-regulations and generally unwise financial actions of governments worldwide, giving rise to the current situation of RI (recession/inflation).
Big Policy mistakes include interest rates of near zero encouraging marginal (at best) investment projects with low real yields that have suddenly been faced with renewal rates that are unaffordable.
They include panic flu-related lockdowns, shutdowns and forced shifts in business investments into exaggerated risk-avoidance along with independently, super-green spending aimed at a problem (in the minds of its critics) a hundred years in the future that caused investors to ignore politically “incorrect” solutions sometimes (as in the case of energy) right under their feet in the form of oil and gas fracking (again that libertarians will consider without preconceived bias).
Real costs obscured
My focus here is not an explanation of those past errors. In this article, I criticize current regulation that takes the form of minimizing, hiding, inadequate response, and worst of all, failing to inform a financially dependent community of citizens in China, America, Europe and everywhere else, just how expensive it will be to address the problem, even in the imperfect fashion now under way.
For example, Janet Yellen, former boss of the American central bank (“the Fed”) and now secretary of the US Treasury, has many times told the public (I paraphrase) “don’t worry, your deposits are safe,” as if that was the main or only problem.
I have been a consultant and visiting professor at the US Federal Reserve, working in the very department that looks after banking problems that required banks to merge, join holding companies, combine in various ways.
This quite often was in order to correct problems that exceeded the monetary competence of the banks that sought help or approval, as they hoped to find the best and, if not the ideal, at least a low-visibility, non-attention-getting solution to their inability to carry on or at least to survive while having a satisfactory level of bank services to customers, to maintain a healthy competitive financial community, and to continue to earn profits satisfactory to their suppliers of bank capital.
Without going into detail about my experience, since my purpose here is simply to list the much larger-than-depositor losses hidden from sight by announcements from all over the world (I mention Yellen merely as an example) from less-than-forthright regulators (and even bankers themselves) who imagine they might thereby exonerate themselves from the responsibility for the degree of trouble we face.
An incomplete but suggestive list of the hidden costs and problems associated with a bailout program includes, first of all, a public display of serious financial trouble.
The reason most readers don’t know that these 553 failures have occurred is that the first thing bank regulators do when faced with a problem bank is to search, sometimes the world over, to find private investors, takeover banks that come quietly to the rescue, so as to avoid making problems worse via, for example, bank runs that spread.
Bailout plans often include de facto ownership by the government of the doubtful assets that are the source of the problem. This was the case in the United States’ mortgage crisis of 2008. The derivative assets the government took on destroyed big parts of the regulatory apparatus.
Enabling gamblers
Bailouts allow bankers, investors, and financial gamblers to take chances they ordinarily would avoid. They think they are on a one-way highway. They take profits but the government takes the losses. But the losses are real, and somebody has to absorb them, quite without their knowledge or acceptance.
More to the point, the taxpayer, or the plain citizen in a system where the government runs things, gets less than he deserves because government money goes to fixing the past instead of building the future.
Bailouts weaken the entire financial industry because the competitive pressure that results when players are motivated by fear of failure is diminished.
Big guys get saved with bailouts while small guys, who often are the source of new ideas, are too insignificant to rescue. Government will not take the real risk of trusting intuition, and take on the chance that the little guy with ideas is a better employer of taxpayer money than is the big guy who has lost his edge.
And of course, sometimes a big guy has ideas so big (Elon Musk wants to take his money to Mars) that not many bureaucrats would finance it. But I bet Musk will be proved right enough often enough to remain the richest man in the world.
Of course, when the regulator, or the rescue agent, has political as well as economic motivation, not all the taxpayer money goes to serve the general interest – some of it, maybe a lot of it, goes to serve a special interest, an interest possessed of political assets, not necessarily very productive ones.
To the extent that previously innovative financial players must take orders from notoriously non-innovative, excessively conservative political bosses, the industry is no longer controlled by makers. The fixers have taken over.
These problems, the ones that go way past lost depositor money, are feature problems for every financial player in the world. East and West, capitalist and socialist, big and little, all must learn that they only lose the respect of their audience if they give reassurances that paper over the size and complexity of the issues.
Taxpaying citizens will forgive, or at least understand, an inability to solve admitted problems. They won’t forgive duplicity. Regulators who recognize this reality have the best chance of keeping their job – into the long term.
Tom Velk is a libertarian-leaning American economist who writes and lives in Montreal, Canada. He has served as visiting professor at the Board of Governors of the US Federal Reserve system, at the US Congress and as the chairman of the North American Studies program at McGill University and a professor in that university’s Economics Department.