Too big to be saved

The global financial meltdown is getting stranger by the minute. Iceland is on the verge of going bankrupt (how can countries go bankrupt? Maybe next time), has nationalized some of its banks, has pegged its fiat currency – the krona – to the Euro (a peg that is not working) and is in talks with Russia for a 4 billion euro rescue package (putting Russian petro-dollars to work).

Swaminathan Aiyar writes about Europe’s hollow claims of superior regulation of financial markets. He refers to an FT op-ed by Daniel Gros and Stephan Micosi which says that Europe’s banks have become too big to be saved-

The crucial problem on this side of the Atlantic is that the largest European banks have become not only too big to fail, but also too big to be saved. For example, the total liabilities of Deutsche Bank (leverage ratio over 50!) amount to about €2,000bn (more than Fannie Mae) or more than 80 per cent of the gross domestic product of Germany. This is simply too much for the Bundesbank or even the German state, given that the German budget is bound by the rules of the European Union’s stability pact and the German government cannot order (unlike the US Treasury) its central bank to issue more currency. Similarly, the total liabilities of Barclays of around £1,300bn (leverage ratio 60!) are roughly equivalent to the GDP of the UK. Fortis bank has a leverage ratio of “only” 33, but its liabilities are three times the GDP of its home country of Belgium.

Aiyar writes further-

The supposed contrast between Anglo-Saxon free-marketeering and European welfare capitalism has turned out to be mostly hot air. The two models have more commonalties than differences. Higher regulation has not crisis-proofed Europe.

and warns that India should be prepared for the fallout.

Meanwhile Bradford DeLong writes about the high priests of finance-

Thus, as social democracy, government guideposts, and centralized planning waxed and waned elsewhere in the economy, social democracy in short-term finance went from strength to strength. First, central banks suspended the rules of the free market in liquidity squeezes. Then they set the price of liquidity as an administered price in normal times. Then they freed themselves of all but the lightest contact with their political masters: they became independent technocrats, a monetary priesthood that spoke in Delphic terms obscure to mere mortals.

The justification for this system was that it seemed to work well – or at least less badly than central banking that blindly adhered to the gold standard or no central banking at all. This island of central planning in the midst of the market economy was a strange and puzzling feature – all the more so because so few remarked how strange it was. There were no calls for a five-percent-growth-of-kilowatt-hours rule as there were calls for a five-percent-growth-of-M2 rule. There was no Federal Automobile Board to set the price of vehicles the way the Federal Reserve Board set the price of federal funds.

But now it appears that, despite all this, we still have not had enough central planning in finance. For, even as the central banking authority administered the price of liquidity, the price of risk was left to the tender mercies of the market. And it is the price of risk that is the source of our current distress.

So few remarked how strange it was? No comments.

The irony in the whole crisis is that politicians and bureaucrats who don’t know the ABCs of economics will now assume more control of economies that they systematically ran into the ground in the first place. The sad part is that the foolish aam aadmi – common man – will suffer the consequences.

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