In a moment of crisis, as during the fall
of 2008, bailing out major financial institutions
seems to be a good idea. However if we keep
doing this we’ll eventually run into what we
could call the Casablanca regret.
(Spoiler alert: if you actually have never seen
the classic movie Casablanca you need to
see it before you read any further
–and after you see it you’ll realize that there are
lots of cultural references that will finally make
sense to you).
When Rick and Ilsa are standing on the
runway at the end of the movie he tells
her that she needs to get on the plane,
contrary to what he had previously told
Captain Renault. Lisa wants to stay. As
Rick self-sacrificially tells her she needs
to go he says, “if you stay you’ll regret it —
maybe not today, maybe not tomorrow, but soon,
and for the rest of your life.”
That’s what happens with bailouts.
You think you’ve done the right thing at
first because an imminent crisis has been
averted, but then the regrets start setting in–
maybe not today or tomorrow but eventually,
and the regrets will be long-lasting. Companies that
have been bailed out start to seem to be
safer investments and thereby acquire an
unfair advantage over other firms and find
they can take more risks, increasing the
chance of a future crisis. The government
has no credibility if it tries to claim
“we will not bail you out next time even
if we bailed you out last time.”
What needs to be done to deal with future
financial crises is to make clear that all
bank deposits wil be 100 percent secure,
and all other investments are risky.
If you don’t want the risk then don’t hold the asset.
Having rules clearly specified in advance will
help because there will be less uncertainty of
what policy will be. If you hold debt that’s not
being paid back, then you need to know that your
rights (but not all your money) will be protected
in bankruptcy court. As long as it’s clear what
assets are safe and what are not, then the rate
of return on different assets provides an
indicator of how much compensation is needed
to entice people to hold the riskier assets.
For how this should change bank regulation, see
https://douglasadowning.wordpress.com/2016/04/06/how-to-improve-bank-capital-requirements/.
the movie Casablanca (IMDB)
……………..
–Douglas Downing
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