Problems of Bank Bailouts

Readers Questions: do you agree with bank bailouts why? or why not?

I wrote here: Why we need to bailout the banks

The Great Depression was so severe because of the scale of banks who went bankrupt. Banks may not deserve to be bailed out, but, it was a necessity. However, bailing out banks has significant problems.

Problems of Bank Bailouts

  1. Moral Hazard. Moral hazard states that if you bailout a bank, then it may influence their behaviour in the future. If governments always bailout banks, then banks are encouraged to take more risks because if they fail, they know the government will come to their aid. If an ordinary firm takes risk and loses, then no-one will bail them out. Therefore, they are more careful about taking excessive risks. But, in the banking sector there were high rewards for taking on risky loans, but the bankers didn’t have to face the consequences when they lost money.
  2. Costly to Taxpayer. Financial sector intervention was costly for taxpayers in UK, US and other European countries. In Ireland, bank bailouts caused the Irish government itself to see rising bond yields and need for its own bailout. See: Irish National Debt
  3. Unfair. Arguably, it is ‘unfair’ for taxpayers to pay cost of bank bailouts because they didn’t cause financial crisis. When manufacturing firms lose money, the government allows them to go out of business. People working in banking sector tend to be highly educated, well paid. But, when unskilled coal miners lose their jobs, there is less support from the government.

US Bank Bailout 2008

The big question is how to bailout the banks. For example, the Paulson plant and Greitner plan have involved purchasing of ‘toxic assets’ rather than taking public ownership. I have never really evaluated all the detail of these plans. But, my feeling is that this is an expensive and inefficient way to bailout the banks.

You will get more detailed analysis here:

Financial policy despair – Paul Krugman

“…Question: what happens if you lose vast amounts of other people’s money? Answer: you get a big gift from the federal government — but the president says some very harsh things about you before forking over the cash….” Bailout for Bunglers

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