A Possible Solution to the Financial Crisis

A Possible Solution to the Financial Crisis

Here is a suggestion after reading Anatole Kaletsky's Article today http://www.timesonline.co.uk/tol/comment/columnists/anatole_kaletsky/article4776149.ece?Submitted=true

Two new organisations need to be created to formalise and eventually commercialise the government's role as 'lender of last resort' and 'insurer of last resort' to financial institutions. I'll call these 'Bigbank' and 'Biginsure'

Bigbank's role is to lend other banks so long as the other bank is solvent.
Bigbank's lending should be to other creditworthy institutions. It should it insure the loans it makes against the risk of default where possible, by buying credit default protection in the open market.
Bigbank's role is to provide 'bridging loans' to other banks who might have temporary liquidity problems due to speculative attack.
Bigbank could (say) have around £100bn of capital. The government providing the initial capitalisation, by buying shares, or by guarantee. So long as the risks on the loans that it makes can be adequately insured, Bigbank can lend many times its' capital.

Biginsure's role is to be an 'insurer of last resort'. Biginsure will insure bigbank against it's counterparty going bust, if no other insurers can be found. Big insure could also insure against other major risks where at present. the government provides a guarantee (e.g. terrorism, natural disasters). Biginsure would be well capitalised, in order to cover quite large potential risks. Biginsure could grow (e.g from an initial size of £100bn of government-owned shares to a size of £1tr) by selling shares to the public, so spreading risk broadly.

Both institutions can act commercially, by providing loans at rates that account for the inherent (although not the speculation-induced) riskiness of lending (because now-solvent institutions might become insolvent in the future). The main role of bigbank is to offer liquidity and thus defend solvent institutions against speculative attack.

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4 comments:

Robin Smith said...

Is the question you are asking: to privatise the central bank further still and split it to resolve an intrinsic and latent systemic problem? How would your proposal affect money supply to the public and what affect would it have on the minimum reserve system. See my blog here for my philosophy on it:

http://gco2e.blogspot.com/2008/09/peek-preview-of-how-we-will-handle.html

Carpe Diem? Live now, now is the most precious time, now will never come again

The credit crunch bailout, nationalisation of the banks, loosening of anti competitive banking regs. Is this the signature of how we deal with existential crises in general?

My concern with this crisis generally, not being an expert, but knowing enough to ask: why does this keep happening, is that we will sweep it under the carpet and the cycle will reach critical again in 10 years. Better to get over it now, hide the irresponsible behaviour and deal with the bigger problem another time or never.

The issue here is that the root cause is so subtle that even the experts and those in power are unable or as above unwilling to recognise it. If the market were left to run its course, yes, there would be immediate pain for many. But we would get to the heart of the matter and the cause would reveal itself. We could then start to form a coherent adaptation policy for the current systemic problems at the root.

I would let it break now and deal with the fallout instead of stealing wealth from future generations.

Philosophically this crisis is analogous with climate change in way. We think only of me, myself, I and how I can protect that in the very short term.

The future is irrelevant. The solution is simple but needs courage. Face the music

TheClimatePhilosopher said...

Yes, that's right: I'm proposing to split and privatise the central bank more to resolve a latent systemic problem.

Money supply would be enhanced because there would no longer be shortage of capital in the system.

The important point is the need to distinguish between liquidity (not enough people willing to lend cash) and solvency (whether the assets of the banks are worth more than the liabilities). The bank needs to ensure medium term liquidity.

The central banks make all sorts of guarantees. I just think these guarantees should be paid for by the banks. Now is not a good time to start of course. But you have to start somewhere.

What you want to avoid is having to nationalise the entire banking system in order to protect depositors, which would have to happen if the high street names got into trouble.

Robin Smith said...

What would happen if they just let the banks crash under the current crises. What would be the immediate and then the longer term effect do you think

TheClimatePhilosopher said...

13th October: Seems like the markets responded positively to the weekend news.

I support the Brown package and I believe it is well thought-out.
I do not support pushing banks to the wall. All this is easier to say now than it would have been 5 hours ago. But of course we are not out of the woods yet and likely to see financial reverses again in next weeks.

In the long term I do not support the current status of banks. Being highly leveraged is not consistent with holding systemic exposure to the economy.
We need banks that can stay afloat event with the 50% fall in house values that is possible or even likely. Putting your money in banks would be more like putting them in stocks and shares if it weren't for the govt guarantee.

The roots of the asset price bubble may be abroad as well as at home with excess savings by China. Unless the Chinese public+private savings rate falls, we have the choice of
a) recession
b) replacing a private-debt fueled growth with public-debt fuelled growth
See http://en.wikipedia.org/wiki/Paradox_of_thrift

I would go with option b) and a 'climate change new deal'. 100 new nuclear power stations (or equivalent including some in wind, clean coal) would cost about £200bn. That would be a start.

I would focus the land-value stuff on shifting incentives onto real investment rather than as a revenue raiser in the near term. My recommendation is to eliminate taxation on dividends as a first step. At present we have a system which disincentives real investment by it's tax treatment. This is driving more of it abroad and is also driving structurally excessively expansionist monetary policy (otherwise you would have a 'paradox of thrift' recession). Breaking out of this needs strong incentives for real investment, particularly in socially beneficial areas (power stations, grid, public transport).

Private sector assets (land values, bank share equity, electricity sector investments) should not be appropriated by government, since this will drive a greater wedge between social and private required returns. But once the housing market is stabilised we can make it clear that there will not in the future be speculative non-productive returns to be made.