02 February 2009

Joe Stiglitz says: let the banks fail!

A very interesting alternative strategy for dealing with the economic crisis comes from Nobel Prize winning economist Joseph Stiglitz. His suggestion? Let the dodgy banks fail, take over their infrastructure and build a new, healthier financial system, in the public sector (at least for a while).

It's similar to my previous suggestion of full nationalisation of the sector in many ways. The only big difference is that in my proposal the banks wouldn't default on their debt payments whereas in Stiglitz's proposal they would - it'd presumably all be dealt with through bankruptcy proceedings.

So there seems to be an emerging consensus on the Left that a state-led reconstruction of the banking system is needed to get us out of this mess. The question is: do you prop up the existing banks without letting them go bankrupt (the cost of which falls on the taxpayer) or do you let the banks go bust (the cost of which falls on their creditors?) To decide that I guess we have to know a bit more about who the creditors are. (I'm assuming that the existing bank shareholders lose out either way - either due to nationalisation or bankrutpcy).

Stiglitz's argument that bankrutpcy would restore some kind of market discipline - banks that took bad decisions would go bust rather than getting a bailout - has a logic to it. But there are externalities to these kind of banking failures. In the short run extra bankruptcies would make the economic situation worse, not better.

Also, a lot of the people who did the damage have already been remunerated - handsomely - for their efforts. I'm talking about huge city bonuses. Maybe we should impose retrospective surtaxes on senior bankers depending on how much taxpayers' money is required to rescue the banks they work for (or used to work for.) Very fiddly, though. A wealth tax would work a lot better.

I'm not sure whether I agree with the Stiglitz position compared with a bailout which incorporates nationalisation. It's a very tough call and I'll be thinking about it some more over the next few weeks.

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