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April 3rd, 2012 12:53 pm
How to Avoid Bank Bailouts: Make the Bankers Liable
Posted by Troy Senik Print

Over at the Wall Street Journal, James Grant, editor of Grant’s Interest Rate Observer has a perceptive review of the new book, “White House Burning: The Founding Fathers, our National Debt, and Why it Matters to You,” by former IMF Chief Economist Simon Johnson and University of Connecticut law professor James Kwak. Two passages deserve special attention.

On the banking system, Grant writes:

Here’s an idea: Let’s try capitalism for a change.

Rather than the bureaucratic monstrosity called the Dodd-Frank Act, for instance, why not hold the bankers personally accountable for the solvency of the institutions that employ them? Until 1935, bank stockholders would get a capital call if the company in which they had invested became impaired or insolvent. It was their problem, not the government’s. In the same spirit, suggests the New York investor Paul J. Isaac, let the bankers forfeit a portion of their past compensation—say, that in excess of 10 times the average manufacturing wage—if they steer their employer on the rocks. And let them surrender not just one year’s worth but rather seven year’s worth—after all, big banks don’t go broke all at once. Proceeds would be distributed to the creditors, as in days of yore. Bankers should not only take risks. They should also bear them.

And on the endless invocation of the Great Depression as the sole object lesson in how to respond to a severe economic downturn:

Messrs. Johnson and Kwak, who draw the usual conclusions from 1929-33, fail to mention the depression of 1920-21. Yet this cyclical downturn was as instructively brief as it was ugly. Peak to trough, nominal GDP plunged by 23.9%, wholesale prices by 40.8% and the CPI by 8.3%. Unemployment, as it was then inexactly measured, soared to 14% from a boomtime low of 2%. And how did the successive administrations of Woodrow Wilson and Warren G. Harding, along with the Federal Reserve, meet this national disaster? Why, they balanced the budget and raised interest rates. Yet for reasons never examined in the pages of this book, that depression promptly ended and the 1920s roared.

Grant’s theme? Responsibility, both personal and collective. That has the great virtue of being the right thing to do. It also has one even greater virtue: it works.

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